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Mark Hulbert
June 1, 2011, 12:01 a.m. EDT
By Mark Hulbert , MarketWatch
CHAPEL HILL, N.C. (MarketWatch) "â? At least one thing is clear in the otherwise cloudy crystal ball when trying to figure out what the Federal Reserve will do when its latest round of quantitative easing, or QE2, ends later this month: A large group of us will be very surprised.
It's just not clear which group it will be.
Although this is frustrating to those of us who want to make bold trading strategy bets for the month of June, there is a way to exploit this unusual uncertainty: betting on greater-than-expected volatility.
Consider how far apart we are about what will happen when QE2 comes to an end.
On one hand are those who are quite confident that the current round of quantitative easing will be followed almost immediately by yet another round "â? QE3.
While it's too early to know the exact form of the easing that the Fed will pursue in the next round, those in this camp say the monetary authorities will undoubtedly continue to throw money "â? lots of it "â? in whatever direction they deem necessary to prop up the economy and the financial markets.
To them, in fact, asking whether QE2 will be succeeded by another round of easing is akin to wondering if the Pope is Catholic. They therefore confidently predict that the end of QE2 will have no impact on the markets this month, because prices have long since taken into account its utterly obvious continuance.
On the other hand are those equally confident that the Fed means what it says: Come June 30, it will no longer be purchasing long-maturity Treasurys and mortgage securities. That doesn't mean the Fed will never, at some unspecified point in the future, create another round of quantitative easing similar to QE2. Just not on July 1.
Ironically, however, the investment consequence of this perspective is identical to that of the opposing camp: QE2's ending will not impact the markets because it has long since been discounted.
As Dan Seiver, editor of the PAD System Report, put it to me in an interview, "You'd have to be crazy to believe the market hasn't already discounted the end of QE2."?
Needless to say, these diametrically opposed analyses cannot both turn out to be right.
What's a trader to do? One course of action, of course, would be to study the arguments and data advanced by both sides, decide which you think is more likely to be right and take a bold bet accordingly.
That's not what the best-performing advisers on the Hulbert Financial Digest's monitored list are doing, however. On the whole, they are not making bold bets one way or the other on what the Fed's next steps will be and they are pulling some of their chips off the table.
/quotes/comstock/20m!i:vix VIX 15.45, -0.53, -3.32%
That may be the best course of action for the month of June, though it's not a particularly exciting trading strategy. Successful trading requires knowing when to hold' em and when to fold "?em, and this might be a good time to do the latter.
If you nevertheless want to pursue a more exciting trading strategy, you might want to bet on an increase in volatility. After all, when it becomes clearer in the next several weeks what the Fed will do after QE2, the group of investors who got it wrong will be scrambling fast to adjust their portfolios accordingly. It stands to reason that an increase in volatility will be a natural consequence.
That isn't how traders are currently betting, however, with the CBOE's Volatility Index /quotes/comstock/20m!i:vix VIX -3.32% just above 17 "â? well below not only its long-term average but also its average over the past 12 months. This means that VIX call options are relatively cheap right now.
Remember, though, that this options strategy is not the consensus recommendation of the top-performing advisers. If you choose to pursue it, do so with your play money only.
/quotes/comstock/20m!i:vix Add VIX to portfolio VIX CBOE MKT VOLATILITY IDX 15.45 -0.53 -3.32% Volume: 0.00 May 31, 2011 4:14p var embeddedchart1085120985Chart = new EmbeddedChart('#embeddedchart1085120985', NormalChartStyleNoDecimals, 240, 80, '1dy', '5mi', null, null, null, 'US:VIX'); jQuery.data($('#embeddedchart1085120985').get(0), 'embeddedchart', embeddedchart1085120985Chart); //$(document).ready(function() { var storywidth = $('#mainstory').width(); var maxwidth = storywidth; $('#maincontent pre').each(function (index, value) { var thiswidth = $(value).width(); if (thiswidth > maxwidth) maxwidth = thiswidth; }); var offset = maxwidth - storywidth; if (offset > 0) { var margin = 13; var blanketwidth = $('#blanket').width(); var contentwidth = $('#maincontent').width(); $('#blanket').width(blanketwidth + offset + margin); $('#maincontent').width(contentwidth + offset + margin); $('#mainstory').width(storywidth + offset + margin); } //});Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
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About Mark HulbertMark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now.
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