Total Contracts Traded:  11

I sold off the rest of my STT contracts yesterday as they report this morning.  One of two things will happen.  When they report, the selloff will be horrible and I’ll feel bad for not leaving some of my shorts on the table.  Or after they report, STT rallies as investors will have more clarity into their business.  Either way, I don’t care to play earnings and STT’s given me a cool 200%+ return so who can complain.

Within the first 15 minutes, my DIA/SPY calls used to hedge against any upside were stopped out.  After seeing the pre-morning action and noticed futures ever so slowly declining, I put the stops in place which were immediately hit.  Needless to say, it worked out fairly well.  I did re-enter into some hedged positions but that may have been a mistake.  I’ll know more when I land later this morning.

Profits:  $377

Yes, I’m hitting new highs.  I re-read parts of Trading in the Zone and should have a post sometime in the next couple of days regarding the last chapter in the book.

First leg of my journey home begins in about an hour.  I’m upset I’ll be missing the market open but hopefully the markets don’t tank too hard without me in the game.

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The markets are currently pricing in a 25bp cut with the potential for a 50bp cut. So how do you figure out what the percentage is? First, here’s a link to the CBOT – Fed Funds 30 Day Futures table. For this exercise, we’ll look at January and February.

• January futures: 96.07
• February futures: 96.945

The first thing you need to do is figure out what the predicted FF rate is. Simply subtract 100 from the current futures price to calculate what the markets are thinking the FF rates will be by the time those futures expire.

• January Predicted FF Rate: 100-96.07 = 3.93
• February Predicted FF Rate: 100-96.945 = 3.055

Aha! Some reasonable numbers. Now we know for the most part the Fed cuts rates in quarter increments. So what’s going on with these odd decimal values? Remember that these futures predict the change in the interest rate by the expiration of that month’s futures. So in order to determine what the markets are predicting, we need to know what the interest rate was prior to that month’s expiration.

• FF Interest Rate Prior to January’s expiration: 4.25%
• FF Interest Rate Prior to February’s expiration: 3.5%

What? Why are the two rates different? Remember that at the last FOMC meeting, the Fed brought rates down to 4.25%. Last week, the Fed held an emergency meeting cutting rates to 3.5%. Since January’s futures were already in play, you must use the interest rate prior to that starting month.

So how do you figure what the markets are “baking” in? Let’s take a look at January’s probability first.

• January Current Rate – Predicted Rate = 4.25 – 3.93 = 0.32

Now that we have the difference, how do we calculate what the markets are predicting? Here’s a quick conversion rate on how to determine what the markets are pricing in:

• 25 basis point cut: multiply current – predicted by 4
• 50 basis point cut: multiply current – predicted by 2
• 75 basis point cut: multiply current – predicted by 1
• 100 basis point cut: multiply current – predicted by 0.5

So now let’s multiply the basis point predictions by our 0.32 difference:

• 25 basis point cut: .32*4 = 1.28 or 128%
• 50 basis point cut: .32*2 = .64 or 64%

As you can see, the markets were predicting an over 100% chance of a 25 basis point cut this Fed meeting with the possibility of a 50 basis point cut. Obviously, we’ve gotten that as a result of the emergency rate cut, so let’s look at February’s futures prices to determine what the Fed will do before then.

• Current rate of 3.5 – Predicted value of 3.055 = 0.445
• 25 basis point cut: 0.445 * 4 = 1.78 or 178%
• 50 basis point cut: 0.445 * 2 = 0.89 or 89%
• 75 basis point cut: 0.445 * 1 = 0.445 or 44.5%

As you can see, the markets are predicting by the expiration of February’s futures that the Fed will cut 25 basis points with a very good possibility of a 50 basis point cut. Remember that the next FOMC meeting is in mid-March so unless the market situation changes, there should be no reason the Fed cuts in February.  For fun, what are the markets predicting the interest rate would be after the meeting in March?

100 – March Futures = 2.89

• Current Rate 3.5 – March Futures 2.89 = 0.61
• 25 basis point cut:  0.61 *4 = 244%
• 50 basis point cut:  122%
• 75 basis point cut: 61%
• 100 basis point cut: 30.5%

From here until March, the markets are predicting that the current rate of 3.5% will be reduced at the very least by 50 basis points, or to 3%.  Remember that the starting interest rate and predictions will change depending on what happens from here until the start of March, but it gives you a decent idea of where the markets think interest rates are heading.  In this case, they’re seeing rates slowly drop, especially after the huge emergency cut last week.

There you have it.  Math class is over.  You’re dismissed!  Play it safe today.  I have a feeling the markets will be disappointed after a 25 bp cut this afternoon.

CBOT’s Guide on How to Read the Fed Funds 30 Day Futures

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