Janet Yellen is turning hawkish, and option traders are taking notice.
"[We] expect the economy to warrant further gradual increases in the federal funds rates,” the country’s top central banker told Senators in prepared remarks on Tuesday. “Waiting too long would be unwise.”
Financials, whose results benefited from higher interest rates last quarter, rallied immediately. There was also an especially bullish options trade in U.S. Bancorp (NYSE: USB), with 5,000 March 55 puts (options to sell) sold for $1.27 and an equal number of March 55 calls purchased for $0.76.
The strategy generated an initial credit of $0.51, but is intended to simulate owning 500,000 shares in the Minneapolis-based lender. The calls (options to buy) will appreciate in value above the strike. The short puts generate income in return for the investor agreeing to buy USB stock if it falls below a certain level. The bet is highly aggressive, with the potential to generate big profits or losses in either direction.
USB rose 0.73 percent to a new record closing price of $54.53 at market close yesterday. Other major financials like Bank of America (NYSE: BAC) and JPMorgan Chase (NYSE: JPM) also rallied to new 52-week highs.
The iShares MSCI Emerging Market ETF (NYSE ARCA: EEM) drew just the opposite reaction, falling almost 1 percent after Yellen spoke. (It later bounced to close up 0.08 percent at $38.37.) The options activity was also bearish as traders amassed more than 28,000 3-March 37 puts for $0.12 and $0.13. Those contracts can appreciate to the downside because they fix the level where EEM can be sold. They will also become worthless if the fund's market price holds its ground.
Higher interest rates tend to lift currencies because savers get a better return on their capital, so Yellen’s comments also boosted the U.S. dollar. That weighed on EEM, whose assets are mostly located overseas.
Aside from Yellen, other items in the news were consistent with higher interest rates. Producer prices, a measure of wholesale inflation, were released yesterday, reflecting a rise of 0.6 percent in January -- the fastest pace in more than four years and twice economists’ forecasts. Richmond Fed president Jeffrey Lacker (not currently a voting member at the national level) added that “rates need to rise more briskly than markets now seem to expect.” Price gains also accelerated faster than expected last month in China and India, according to reports overnight.
In summary, Tuesday’s activity followed the theme of higher inflation and higher interest rates. It’s a continuation of the pattern that began last summer and reflects a sense of confidence in economies at home and abroad.