Options are hedging against dovish results on Fed hikes

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Options are hedging against dovish results on Fed hikes

Options traders are taking bets that will gain if investors scale back expectations of tighter futures and hedging against dovish results, with the expectation that the Federal ReserveFederal Reserve will dial down its hike pace at its Feb. 1 policy meeting.

Nearly half a percentage point of rate cuts have been factored in for the second half of the year, according to Bloomberg.

If the central bank hikes its benchmark rate by 25 bps next week, it could be its final move in a tightening cycle, it said.

The report highlighted a dovish trade seen in the options market where a $40 million position was built up, which would gain from around 25 basis points of the rate-hike premium being priced out of September 2023 futures.

Treasury Futures: Even the Treasury futures market is indicating that this could be the peak of the central bank's rate hike cycle. Net-short leveraged positions in 10 year Treasury futures by hedge funds have risen to the largest levels since 2019, while net-long positions taken by institutional investors have risen to record highs.

This level of contrarian positions by these classes was last seen in late 2018 when the Federal ReserveFederal Reserve's rate tightening cycle was about to reach its peak.

Some experts have voiced their opinions on the rate hike path. Allianz chief economic adviser and economist Mohamed El-Erian said he is among a small group of people who think the Federal ReserveFederal Reserve should not be downshift to 25 basis points and stick to a 50 bps rate hike.