The Fed and the Wall Street Put

Abstract

We study the trading behavior of financial intermediaries around Federal Open Market Committee (FOMC) announcements in the S&P 500 index options market using intraday data. In contrast to other days, proprietary trading firms are net sellers of options on FOMC days, with their trading activity concentrated in the morning, well before the announcement.  Larger option sales by proprietary trading firms in the morning  predict both a more accommodative monetary policy shock later in the day and a subsequent decline in option prices after the policy announcement, rendering morning trades profitable. We decompose monetary policy shocks into three components and evaluate potential explanations for these findings. Our analyses suggest that some financial institutions may have the ability to predict financial markets' reaction to Fed policy announcements. 

Keywords: monetary policy, intermediaries, equity options, Federal Reserve