Fed Put in the Equity Options Markets

89 Pages Posted: 28 Jun 2017 Last revised: 24 Aug 2022

See all articles by Sandeep Dahiya

Sandeep Dahiya

Georgetown University - Department of Finance

Bardia Kamrad

Georgetown University - McDonough School of Business

Valerio Potì

University College Dublin

Akhtar R. Siddique

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Date Written: January 9, 2019

Abstract

We look at the effects of monetary policy on the stock market and market participants' expectations through the lens of the equity option market. Options permit us to distinguish the effect of monetary policy on the cost of capital from its effect on market expectations about the future payoffs to equity investors. Given the difficulties in identifying monetary policy stance, we use several distinct approaches, such as natural language processing of FOMC minutes, regime switching models, and deviations from Taylor Rule. We address reverse causality using conventional instrumental variables method as well as causal forest based methods. We find that, with loose Fed monetary policy, traded equity put (call) options are significantly cheaper (more expensive) versus with tight monetary policy. We interpret this as a manifestation of the ``Fed Put". Accommodative monetary policy also creates a moral hazard as out of the money call options exhibit higher prices. We find some evidence that the effect of Fed policy on option prices reflects an expectation that the Fed will support the stock market even beyond the extent to which the real economy may need support.

Keywords: Fed Funds Rate, Implied Volatility, Volatility Skew Surface, Greenspan Put.

JEL Classification: E44, E528, G13, G28

Suggested Citation

Dahiya, Sandeep and Kamrad, Bardia and Potì, Valerio and Siddique, Akhtar R., Fed Put in the Equity Options Markets (January 9, 2019). Available at SSRN: https://ssrn.com/abstract=2993326 or http://dx.doi.org/10.2139/ssrn.2993326

Sandeep Dahiya

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-3832 (Phone)

Bardia Kamrad

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

Valerio Potì

University College Dublin ( email )

M. Smurfit School of Business
Carysfort Avenue, Blackrock
Dublin, Co Dublin
Ireland

HOME PAGE: http://https://people.ucd.ie/valerio.poti

Akhtar R. Siddique (Contact Author)

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street SW
Washington, DC 20219
United States

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