Investors game Bernanke, bet market will settle

Investors hoping Fed Chairman Ben Bernanke will make juicing the market a standing feature of his annual retreat in the mountains of Wyoming have awaken to reality.

New York: Investors hoping Fed Chairman Ben Bernanke will make juicing the market a standing feature of his annual retreat in the mountains of Wyoming have awaken to reality.

The growing consensus is that the Fed's options to stimulate the flagging US economy are limited. But the markets have been extraordinarily volatile -- in part because investors don't know what Bernanke will say on Friday.

So some investors are betting against the jumpiness, expecting markets to calm down once Bernanke takes the podium at 10 a.m. ET in Jackson Hole to discuss the Fed's options.

Tony Battista, Chicago-based Tastytrade managing director, said the uncertainty that has driven certain trades in recent weeks -- rising bond and gold prices and higher volatility - should fall out of favor once Bernanke has spoken.

"That's what we think about this news with Bernanke -- we'll whipsaw for a half-hour, an hour after he speaks, but volatility? No matter what Bernanke says, volatility should get crushed," he said.

He's betting the wild swings will decline by selling call options and put options in the PowerShares Nasdaq 100 ETF , or the QQQs, at a price above and below the current share price of USD 51.83.

That trade makes money as long as the Nasdaq-100 stays in a range, a bet on the gyrations of recent weeks subsiding.

Markets have been very hard to read during the S&P 500's near 20 percent dive since the end of July. Taking a firm positions ahead of Jackson Hole takes a strong stomach.

Last time central bankers met at Jackson Hole Bernanke sparked a 30 percent rally in stocks over the following eight months by alluding to what would turn into a USD 600 billion bond buying program.

So far this week the S&P 500 is up nearly 4 percent while spot gold has tumbled more than 5 percent.

The VIX closed on Thursday at 39.76, suggesting investors expect the stomach-churning action will continue. Options activity has been frenetic in recent weeks as investors try to protect themselves against near-term gyrations in markets.

Anticipation of some sort of new policy prescription has been dampened, as many believe the Federal Reserve has limited options after spending USD 2.3 trillion in previous efforts to boost asset prices and saying it will maintain short-term rates at near-zero through 2013.

Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut, says investors want to stay positioned against the dollar. He is not expecting any great surprises from Bernanke's speech.

"We are advising customers to still short the dollar," he said. "The Fed has already telegraphed what it's doing, that rates will be on hold through mid-2013."

Short of a new round of quantitative easing, some traders are betting the Fed might sell short-dated Treasuries in favor of the long bond in a bid to stimulate mortgage refinancing and lower other long-term borrowing costs.

"The bond market seems to be pricing in that he's going to address it," said Steve Luetger, head of fixed income management at Mesirow Financial in Chicago, which manages USD 57 billion in assets.

Speculation Fed action may come in the form of increased buying in long-dated bonds has helped rally the 30-year bond.

"Some of the air might come out of the Treasuries market" if Bernanke doesn't strongly signal more stimulus is coming soon," he said.

Calmer waters ahead

Some see the Bernanke speech as a pivot before calmer waters ahead.

"We're in an extraordinary time right now when people are demanding options in the very short term...and that is completely different from what we have seen in the past few months," said Steve Place, a co-founder of options analytics firm InvestingWithOptions in Mobile, Alabama.

But Place thinks investors should lean against that through buying bearish "put spreads" in an ETF that invests in short-term contracts on the CBOE Volatility Index, or VIX, the market's favored gauge of anxiety.

The idea behind a bet on the iPath S&P 500 VIX Short Term Futures exchange-traded note is that it profits if volatility declines in the near-term and rises a few months down the road.

"Regardless of the direction of the move tomorrow, there is a very heightened anticipation with respect to what is coming up right now."

Battista also thinks investors should be going short government bonds and gold because of their recent runs, and because the panic doesn't match the 2008 financial crisis, underscored by Berkshire Hathaway's USD 5 billion investment in Bank of America .

"We don't think it's a 2008 scenario - that's our feeling...and that got validated today by (Warren) Buffett buying (shares of) Bank of America," he said.

Bureau Report