Options Traders Craving Volatility Look Past Fed to Jobs Data

(Bloomberg) — Even as the Federal Reserve meeting and $5 trillion quarterly triple-witching options expiry loom over the equity market, volatility traders are also circling the upcoming jobs data on their calendars.

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The Fed is expected to cut interest rates on Wednesday and quarterly equity options on stocks, exchange-traded funds and indexes will expire Friday in an event that some say clears out dealer positions. While those ordinarily look quite enticing for traders betting on bigger market swings, this time they aren’t expecting volatility to make an immediate return.

With a 25 basis-point rate cut fully priced in, investors will be watching the press conference closely for dovish or hawkish rhetoric from Fed Chair Jerome Powell. Beyond that, the focus is on employment for hints as to how fast and deep the central bank will lower US interest rates.

Options markets are pricing in a 0.78% move for the US nonfarm payrolls report Oct. 3 and 0.72% for Wednesday’s Fed rate decision, according to Citigroup Inc.

“If you threw up a minus 50k payrolls next month you’re gonna get vol higher,” said Stuart Kaiser, head of US equity-trading strategy at Citigroup, adding that negative payrolls are likely needed to get swings higher. “I don’t think there’s any way around that. You probably need the unemployment rate to be around 4.5%.”

Further deterioration in jobs data after US weekly unemployment claims jumped to the highest in almost four years could encourage a faster pace of rate cuts. While that may give the market a boost in the short term, it raises the risk of a selloff.

“History shows that during emergency cuts in particular, intraday market returns are usually positive, but medium-term returns often turn negative, since markets interpret the cuts as a signal of rapid economic deterioration,” said Garrett DeSimone, head quant at OptionMetrics.

Lost in the shuffle a bit is Friday’s triple-witching expiration, with market watchers downplaying its impact. Looking back over 35 years reveals that intraday swings in the S&P 500 Index on expiry weeks tend to be marginally higher than the following week, which challenges the oft touted “free to move” theory.

That theory says that markets are more free to move when dealer options positions roll off, removing the calming impact of the dealers selling into rallies and buying the dips to rebalance their positions. But that tends to be seen when volatility is higher, according to DeSimone.