At least one of the “two rate cuts before year-end” will be a 50 basis point cut? Options market bets that the Fed will “do more.”

```

Options market traders are betting that the Federal Reserve will make at least one large 50 basis point rate cut by the end of the year, a more aggressive expectation than the two 25 basis point cuts currently priced in by the interest rate swaps market.

Recently, options markets linked to the Secured Overnight Financing Rate (SOFR) show that traders are building positions for a 50 basis point rate cut at the Fed’s October or December meeting.

Open interest in December SOFR options has surged sharply; these options expire two days after the policy announcement on December 10, making them ideal tools for betting on the outcome of the remaining two meetings this year. This bullish sentiment is also reflected in the spot market; the yield on the U.S. two-year Treasury note recently fell to around a yearly low of 3.5%.

Although the release of key data such as jobs has been delayed for weeks due to the U.S. government shutdown, the market expects that once the government reopens, a large amount of economic data will provide further evidence of economic weakness, thereby supporting more rate cuts.

Options Bets Focused on Substantial Year-End Rate Cuts

The options market is an important window into trader expectations, and recent signs point clearly towards bets on more aggressive Fed action.

Options linked to the December SOFR have seen obvious buying activity, and their open interest—a measure of traders’ exposure to new risk—has risen sharply. Since these contracts expire two days after the Fed's policy announcement on December 10, they have become ideal tools for wagering on the policy direction of the remaining two meetings this year.

This week’s trades have continued last week’s trend, as traders bought various option structures aimed at hedging “dovish scenarios” (such as a 50 basis point rate cut).

Details of the transactions show that funds have bought 96.50/96.5625 and 96.50/96.625 call spread combinations, and on Monday there were buyers of the 96.5625/96.75 call spread combination. All these trades point to the possibility of a 50 basis point cut at the October or December meeting.

To understand these bets, you need to first understand SOFR. SOFR (Secured Overnight Financing Rate) is the key rate reflecting the cost for institutions to obtain overnight funding using U.S. Treasuries as collateral. As it is based on real transactions in the trillions of dollars daily, and is collateralized by Treasuries, its credit risk is extremely low.

SOFR options are financial derivatives based on SOFR rate futures. Simply put, traders buy and sell SOFR options to bet on the future direction of short-term rates. The price of interest rate futures moves inversely to rates themselves—a price rise means the market expects rates to fall.

Therefore, when traders buy SOFR call options en masse, they are actually betting that the Fed will cut rates. Buying a series of calls with high strike prices indicates they believe the size of the cut could be substantial.

Multiple Indicators Show Dovish Tilt

Besides the SOFR options market, several other market indicators also reflect investors’ dovish bias.

According to a JPMorgan client survey for the week ending October 14, the proportion of investors holding neutral positions rose to a one-month high, while the share of bearish positions dropped by four percentage points, indicating that the willingness to short rates (i.e., bet on rate hikes) is diminishing.

In the U.S. Treasury options market, the premium for call options used to hedge against a rise in 10-year Treasury futures prices (i.e., a fall in yields) over put options has climbed to its highest level since April.

This suggests that traders are willing to pay higher premiums to guard against a bond market rebound driven by rate cut expectations. Vanguard portfolio manager John Madziyire said:

Considering the balance of risks, you really want to lean a little bit toward the long side.

Risk Disclaimer and Limitation of LiabilityThe market has risks, and investments should be made with caution. This article does not constitute personal investment advice, nor does it take into account the specific investment objectives, financial situation, or needs of any individual user. Users should consider whether any opinions, views, or conclusions in this article are suitable to their individual circumstances. Investment based on this article is at your own risk. ```