Market Insights

Federal Reserve news this week could trigger volatility. This article will consider three potential hedging strategies before the events.

First, here are the potential catalysts:

• Today at 2 p.m. ET: The central bank will release minutes from its last meeting. While minutes don’t usually move stocks, they could still be closely watched.
• Friday at 10 a.m. ET: Chairman Jerome Powell speaks at Jackson Hole, Wyoming. His address could have a big impact on sentiment by influencing interest-rate expectations.

The basic question is how aggressively the Fed will cut interest rates over the remainder of 2025. Futures pricing tracked by CME’s FedWatch tool shows the market expecting a 25 basis-point cut on September 17 and at least one more in October or December.

However, last week’s inflation readings were higher than policymakers’ target. Initial jobless claims also show a relatively tight labor market. Those points could potentially argue against aggressive rate cuts.

Traders worried about volatility can use various option strategies. Here are three potential approaches they may consider:

• Vertical put spread: Target a move down to a certain level.
• Collar: Protect gains on stock positions.
• High-Vega puts: Isolate volatility from movement.

OptionStation Pro, highlighting Microsoft (MSFT) contracts cited in this article.

Vertical Put Spread

Puts often gain value when stocks fall because they fix the price where a security can be sold. Traders can also combine long and short legs in a vertical spread to leverage a move between two prices.

For example, Microsoft (MSFT) has drifted lower after hitting a record high above $550 late last month. It closed yesterday at $509.77. Investors worried about more downside could:

• Buy 1 September 490 put for $4.65.
• Sell 1 September 480 put for $2.63.

Such a trade would cost about $2. It would expand to $10 if MSFT closes at $480 or lower on expiration. That’s a potential gain of roughly 400 percent from the stock dropping 6 percent. The position will expire worthless if MSFT remains above $490.

Vertical spreads have another drawback: Maximum gains occur at the the lower strike, so moves below $480 won’t make any additional profit.

Collar Trade

Say an investor purchased 100 shares of MSFT before its recent rally and is now sitting on big gains. He or she could hedge with a “collar” strategy:

• Sell 1 September 530 call for $4.05.
• Buy 1 September 490 put for $4.65.

Such a trade would cost $0.60 per share, or $60 in total. Because the investor owns stock, they can sell calls against the equity to collect a credit. That cash can then be used to buy puts with the potential to gain value if prices fall. The collar will expire worthless if MSFT remains between $490 and $530.

Collar vs Spread

Investors might recognize some key differences between vertical spreads and collars.

Cost:

• Spreads cost more because the trader sells contracts further from the money.
• Collars cost less because the contracts bought and sold are roughly the same distance from the current price.

Assignment risk:

• Spreads have assignment risk if the underlier (in this case, MSFT) is between the strike prices. The trader may be assigned a short position on MSFT. If they own shares, it could result in their stock being sold at the higher strike.
• Collars have assignment risk to the upside and downside. If MSFT rallies above $535, they could be forced to deliver shares for that price. If the stock falls under $485 and the investor holds the puts through expiration, their stock will be sold at the strike price. He or she can avoid this by selling the puts before expiration.

Profit to the Downside:

• Vertical spreads have limited profit potential to the downside, only profiting down to the lower strike.
• Collars have more profit potential to the downside because the long put increases as the stock falls. It effectively provides protection all the way down to zero.

Upside Exposure:

• Vertical spreads let investors remain exposed to further upside. For example, if MSFT jumps to $600 or $700, they will still profit from the shares they own.
• Collars limit upside because they involve short calls. In this case, the most they can receive for the stock is $535.

In other words, collars are “cheaper” because they surrender future potential profits to protect against potential downside. Spreads cost more, but “keep you invested.”

Invesco QQQ (QQQ), daily chart, showing implied volatility.

High Vega Puts

Another alternative is to buy puts on an exchange-traded fund (ETF) like the Invesco QQQ Trust (QQQ), which tracks the Nasdaq-100.

Traders can potentially buy vertical put spreads on QQQ if they expect the broader market to decline.

They might also consider long-dated puts that are far out of the money. These contracts tend to have higher Vega, which makes them sensitive to potential spikes in volatility. (See this article for more on option Greeks like Vega and Delta.)

For example, QQQ’s 18-September 2026 250 puts have 0.23 Vega and cost about $1.65. They will gain about $0.23 for every 1 percentage point that implied volatility (IV) increases on QQQ.

This strategy essentially isolates volatility for investors to trade. It can potentially make sense when volatility is near the bottom of its long-term range, as it now is. (See the chart.) For example, if IV climbs from roughly 20 to 30 percent, the puts cited above could gain about $2.30 — more than doubling.

While other strategies can make more money from such a drop, long-dated puts have other potential benefits:

• With more than a year to expiration, they have little time decay for the next few months. As a result, investors can hold them as a general hedge over several weeks. That can make them potentially useful amid events like Fed speeches and Labor Day, which often sees higher volatility.
• They only have 0.02 delta, which reduces their losses from a potential rally in QQQ. Shorter-dated put strategies can lose significant value from prices moving higher

In conclusion, investors may think they don’t need to hedge when volatility is low. But such moments can also make protective strategies more affordable. Trades like vertical spreads, collars, and long-dated puts each have unique costs, benefits and risks. Investors should consider these trade-offs to understand whether a given strategy works and aligns with their goals and risk tolerance.

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