An old proverb asserts that there are only two certainties in life: death and taxes. Well, at the moment, there’s one more certainty: another increase in the fed funds rate by the Federal Reserve at its next meeting. As my colleague John Persinos would say, when confronted by daunting market news: Ugh!

That said, when the cat’s away, the mice will play. So, with the Fed’s next meeting taking place on March 20-21, and the stock market currently oversold after a dismal month of February, the odds favor a short-term bounce in stocks.

That’s because traders have a poor memory, which often means that yesterday’s reasons to be bearish are soon forgotten. Thus, with the Fed thankfully moving to the background for a few days and the stock market oversold, as long as key technical support levels hold, there may be some short-term trading opportunities on the long side.

Of course, we’re not out of the woods for the longer term, as the macro environment continues to shift. Here are several factors which could derail any short-term bounce:

• Ukraine, where an escalation of hostilities is likely as Russia begins as spring offensive and Ukraine attacks assets inside Russia;
• Prior Fed rate increases could start to bite even as inflation may reassert itself creating more uncertainty;
• Economic data provide unexpected adverse surprises, e.g. private market data steadily worsens and government numbers such as the payrolls data continue to paint a rosy picture; and
• The threat that U.S. Treasury bond yields (see directly below) climb above key price chart points.

It’s All About the Fed and Bond Market

Despite all the uncertainty, one thing remains true. The relationship between the Federal Reserve and the bond market is the central cog in what happens to the financial markets and the economy. Familiar readers are aware of my MELA system, a term I coined to describe the process of how the stock market became the tail that wags the dog of the economy.

Simply stated, when stocks rise in price, we see improvements (albeit on paper) of 401k plans, Individual Retirement Accounts (IRAs), and trading accounts (including crypto, or whatever is left of that imploding universe). As a result, people are more willing to spend money. Of course, stocks rise when the Fed is easing monetary policy, which in turn usually leads to falling market interest rates such as the U.S. Ten Year note yield (TNX).

Interactions among the Fed, the bond market, and the stock market influence people’s spending habits which in turn fuel economic activity.

Specifically, the Fed’s actions influence market interest rates, such as mortgage rates and auto loans. When the Fed lowers rates, the money spigots are opened and the economy rises because financial assets rise in price and people feel wealthier. When the Fed raises rates, the tap dries up and the economy stalls because of the influence these actions have on the MELA system.

The chart for TNX shows that over the last few weeks, the yield trend has reversed to the upside. This rise in yields has been in response to tough talk from the Fed, along with its seemingly never ending and grinding interest rate increases. At the same time, the rise in bond yields may have also been exacerbated by creeping loan defaults in commercial real estate, due to the Fed’s rate hikes, and the potential for a full-blown liquidity crisis, as I detailed here.

The bottom line is that the rally in stocks, which started in October 2022, just as bond yields rolled over, finally stalled in January as bond yields bottomed out and begin to climb. However, with a three-week waiting period before the Fed’s next rate hike, any sign of economic weakness could easily trigger a fall in bond yields which would once again prompt traders to buy stocks, even for a few days.

Important Price Chart Points to Consider

As any investor knows, the markets will fluctuate. Thus, as I noted above, with the Fed on the backburner for now, there is a possibility for a bounce in stocks, barring another bond market hiccup.

As a result, with nearly three weeks before the next interest rate increase from the Fed, the S&P 500 (SPX) is trying to recover some of its recent losses. Here are two key chart points to consider before getting caught in a dangerous and costly market whipsaw:

• The 50- and the 200-day moving averages along with the 4,000 price area are crucial support levels. If SPX can hold these levels, that would be a short-term positive; and
• The 4% yield for TNX, as shown above, also is crucial. If TNX doesn’t climb above this important yield area, it would be be a short-term positive for stocks.

Finding the Right Instrument to Trade for a Short-Term Bounce

A low risk and potentially high reward trade which is suitable for a period of time when there is the near certainty of an event by a certain date is an options play. The current market, which is oversold, has created some low price opportunities with the potential for an excellent return coupled with a limited loss if things don’t work out. I’m talking about a simple call option.

A great vehicle for this trade is the Van Eck Vectors Semiconductor ETF (SMH). This exchange-traded fund invests in large cap semiconductor stocks such as Texas Instruments (NSDQ: TXN) and NVIDIA (NSDQ: NVDA). These large cap stocks tend to respond to short term trading turns in the market as day traders and hedge funds with short term strategies gravitate to them.

Currently SMH has the following technical characteristics which make it a great vehicle for a short-term option trade:

• It held above its 50-day moving average during the recent market’s decline, which is a sign of relative strength;
• The Accumulation Distribution Indicator (ADI) is rising, which means few short sellers are active in the shares;
• On Balance Volume (OBV) is stable, which means there is interest from outright dip buyers who are moving in slowly without tipping their hand; and
• The Relative Strength Indicator (RSI) is trading around 50, which means that sellers are no longer interested in selling.

How to Play a Short-Term Bounce with a Call Option

Now that we’ve identified a great underlying instrument for the trade, here are the details.

In this case, a call option makes sense because we are betting on an oversold bounce since the Fed won’t raise rates for three weeks.

In this case, I would buy an SMH April 21, 2023 $250 Call Option (SMH0421202325000C000), which was recently trading at around $7.65 per contract.

When you buy this option, you have the right to purchase the shares of SMH at the strike price of $250 by the expiration date of April 21, 2023. But the best aspect of the trade is that if the shares of SMH rise, you can expect the option to rise in price as well. Moreover, if SMH rises to $250, the option is in the money, which means the price will appreciate on a 1 to 1 basis with the ETF share price.

On the other hand, if the price of SMH falls, you can close out the option trade to cut your losses.

In any case, if you bought 100 shares of SMH at the recent price of $240, you would have a $24,000 expense, while the option, which has the potential to move decidedly higher only costs $765 per contract, based on recent pricing. In addition, the most you could lose is your upfront cost, $765 per contract.

Bottom Line

We know the Fed will raise interest rates in about three weeks. We know the market is likely to get very volatile when that time nears and that it could get worse after the fact. We also know that the market may rally before the event just because traders have a short-term memory when it comes to buying stocks.

As a result, using a call option tied to a liquid ETF such as SMH, which is oversold and has the potential to rally because it holds stocks which usually rise during bullish trends, is an excellent way to participate in any bounce while keeping the potential for losses at a reasonable level.

Finally, what would make me more bullish? For one thing, a failure of TNX to rise above 4%. For another, it would be even more awesome if Fed Chief Jerome Powell just didn’t hold a press conference after the Fed’s rate announcement in March.

Editor’s Note: If you’re looking for growth opportunities in this uncertain market, I suggest you consider the advice of my colleague Dr. Joe Duarte.

As chief investment strategist of our premium trading service Weekly Cash Machine, Dr. Duarte leverages a “fear-based” algorithm that uncovers instant cash codes that could generate up to $1,600 per week in extra income, regardless of Fed policy, the path of inflation, or other adverse macro trends.

In fact, Dr. Duarte’s methods actually thrive on market volatility. Get the details by clicking here.