Treasury yields kept climbing this week, with the 10-year closing at 5.28%. Even so, a weak jobs report and falling odds of an October hike were enough to lift stocks on Friday, and QQQ finished the week higher. Markets are always weighing one force against another, and this week was a reminder that the balance matters more than any single number.
Weekly Recap
The market spent the week talking itself out of an October hike. A week ago, fed funds futures priced about a 64% chance of a 25bps move. By Friday that was roughly 16%. Wednesday's August Core PCE rose 3.0% year over year, softer than expected, and New York Fed President Williams said there was no urgency to move. Friday's jobs report finished the job. Payrolls rose just 29K against roughly 90K expected, and unemployment rose to 4.2%. QQQ gained 0.7% to $749.58, SPY slipped 0.2% to $769.64, and IWM fell 0.2% to $281.52. On earnings, Micron (NASDAQ: MU) beat with revenue of $54.23B and guided Q1 to $61.5B, well above consensus. Softer margin guidance and higher capex still left the stock down 0.7% on the week. Nike (NYSE: NKE) beat on EPS but missed on revenue and guided to a high single digit sales decline. Carnival (NYSE: CCL) rose almost 16% on record results.
Rates did not follow the Fed story. The 10-year Treasury yield ended Friday at 5.28%, up from 5.18% a week earlier, with the 2-year at 4.84% and the 30-year at 5.61%. Yields fell after the jobs report and then reversed higher into the close. Thursday's ISM Manufacturing missed at 54.5 against 55.0 expected, but prices paid jumped to 77.9 from 71.1. Inflation also built abroad. The Reserve Bank of Australia hiked 25bps to 4.60%, and euro area flash CPI jumped to 3.8% against 3.6% expected. Oil eased into the weekend, with Brent near $102 and WTI at $91.11, after the G7 agreed to release 100M barrels of crude and diesel. The Strait of Hormuz remains unresolved.
What I'm Watching Next Week
With an October hike now largely priced out, the question is whether the Fed agrees. Wednesday's FOMC minutes from the September meeting lead the week, since 16 of 18 officials projected another hike this year. A hawkish tone would push hike odds back up and lift front end yields. Monday's ISM Services is expected at 55.7 after 55.4, and a hot prices component would undercut the softer read from Core PCE. Supply matters too, with the 10-year auction on Wednesday and the 30-year on Thursday. Weak demand at these yields would push long rates higher still. Friday's preliminary Michigan sentiment is expected at 48.1, and one-year inflation expectations, last at 4.6%, are the part the Fed will watch. Globally, the Reserve Bank of India is expected to hike 25bps to 5.50% on Wednesday, adding to the global tightening theme. ECB speakers, including Lane and Schnabel on Monday, will give the first reaction to Friday's 3.8% CPI, and hawkish comments would firm up pricing for another ECB hike.
On earnings, the one I am most focused on is Delta Air Lines (NYSE: DAL), which reports Friday before the open with consensus near $2.20 in EPS and $18.8B in revenue. With Brent still near $100, the focus is fuel costs and whether premium demand lets Delta hold fares into its Q4 guide. PepsiCo (NASDAQ: PEP) reports Thursday before the open with consensus at about $2.30 in EPS and $25.0B in revenue. The stock sits near its 52-week low, so volumes and margins matter more than the headline as a read on how much pricing the consumer will still accept.
Research
Here is a simple question. A stock trades at 100, rates are zero and there is no dividend, so the forward is also 100. What is the most a 100 strike put can be worth? The stock cannot fall below zero, so the put can never pay more than 100. Now the call. Its payoff has no ceiling, so it is tempting to say there is no limit. But no one would pay more than 100 for the right to buy a stock that costs 100 today. Owning the stock does at least as well as owning the call in every outcome, so the call is capped at the price of the underlying. Both options top out at 100, and they only approach that level as implied volatility goes to infinity.
Those caps are not a coincidence. Put call parity ties the two options together. Buying a call and selling a put at the same strike and expiry gives exactly the same payoff as owning the stock and paying the strike at expiry. So the price gap between them has to equal the stock minus the present value of the strike. Measured against the forward, it equals the discounted forward minus the strike. There is no volatility term anywhere in that relationship. A call and a put at the same strike always carry the same volatility value, and any difference in their prices comes from carry. Take a stock at 100 with a 5.5% carry rate and a $10 dividend. The forward is 95.5. A 100 strike put looks expensive against a spot of 100, but it is 4.5 in the money against the forward. If the gap ever drifted away from parity, a trader could buy the cheap side, sell the rich side and hedge with stock for a riskless profit.
The bounds also add up in a way that surprises people. A 100 strike straddle is worth at most 200, not 100, even though only one leg can pay at expiry. Sell the straddle at 200, buy 100 shares, and the position never loses. That works because the straddle's delta drifts toward +100 as volatility rises. It is also why an at the money straddle is only roughly delta neutral at normal volatility.
Everything above holds exactly only for European options, which can be exercised only at expiry. American options can be exercised at any time, and that changes both the bounds and parity. An American put can be worth up to the full strike today, rather than its present value, because the holder can exercise immediately and collect the cash. When rates are high, exercising a deep in the money put early can make sense, since the strike starts earning interest sooner. An American call on a stock with no dividend should never be exercised early, because it is always worth more alive than exercised, so it trades like a European call. A dividend changes that. An in the money call may be exercised just before the stock goes ex dividend to capture the payout. The result is that parity becomes a range rather than an exact equation. This matters in practice. SPX options are European and cash settled, while SPY options are American, so the same trade can behave differently near a dividend or deep in the money.
These moving parts are what make options interesting. A stock position is a view on direction, either long or short. An option price bundles several things together: direction, volatility, carry, time and exercise rights. Each of those can be traded on its own. A trader can be long volatility by buying a straddle and hedging the delta, or short volatility by selling one. They can also take a view on skew or carry without any view on where the stock is going. The bounds and parity above are what make this possible, because they show which parts of the price are fixed and which parts are open to a view.
The practical takeaway is to check the boundaries before reading an option price as a view. Know the most each option can be worth, measure moneyness against the forward, and know whether the contract can be exercised early. The same applies when using options to express a view. If you are bullish, buying a call is one way to get long, but the premium is not only paying for direction. It also pays for volatility, time and carry. If implied volatility is high, the stock can rise and the call can still lose money as that premium comes out. So deciding to just buy a call is not enough. The question is whether every part of what you are paying for is fairly priced. Much of what looks like a cheap call or an expensive put turns out to be carry, exercise rights or the limits of the payoff, not a forecast.
Personal
I have been continuing to trade and keep tweaking the models I use. One thing I have noticed is how quickly an edge disappears these days. An idea that used to work for a long time now fades much faster once the market catches up to it. That means the work is never really finished. A model is only useful while the edge behind it still exists, so it needs regular checking and adjusting rather than being left to run on its own.
Outside of markets, I am running my second marathon this Sunday. Like trading, it mostly comes down to the preparation behind it, and I am looking forward to race day.
Disclaimer: Everything here reflects my own opinions and is shared for informational purposes only. It is not financial advice, and nothing in this report is a recommendation to buy or sell any security.