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Investors Brace for Several Big Events Next Week

Reuters
Thursday, 13 Sep 2007 | 3:40 PM ET

Fasten your seatbelt.

Investors face a number of market-moving events next week, including a Federal Reserve meeting on interest rates, major bank earnings and "quadruple witching" in options and futures markets.

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Quadruple witching refers to the expiration of four different options and futures contracts, which occur each quarter on a Friday, and this time falls on Sept. 21.

The two-day phenomenon could create sudden spikes and dips in the market and volume as some investors at the last minute exercise their derivative positions or roll them forward.

Most September stock index options and some index futures, such as the Standard & Poor's 500 futures, cease trading on Thursday and settle on Friday's opening. Individual stock
options, options on the S&P 100 index and single stock futures go off the board after Friday's close.

The Fed's meeting on interest rates on Tuesday presents another unknown, with markets wondering whether policy makers will cut the benchmark interest rate, and by how much.

What Will Fed Do?

"We do not know what the Fed will do. Then the question is how much will they reduce the current rates," said John Person, president of Nationalfutures.com, an advisory service based in
Palm Beach, Florida.

Economists expect the central bank to cut the benchmark federal funds rate, currently at 5.25%, with some arguing that August's surprise drop in U.S. non-farm payrolls justifies a half-percentage point move.

"The uncertainty is causing traders to hedge their cash positions with the derivatives market, and as they unwind these positions after the Fed meeting, this could cause an increase
in volatility," Person said.

But even before the Fed meeting, Lehman Brothers Holdings will be the first investment bank on Tuesday to report third-quarter results, shedding light on just how badly the market mayhem this summer spawned by subprime mortgage losses has hurt profits.

Morgan Stanley follows with earnings on Wednesday, while Goldman Sachs Group and BearStearns report on Thursday.

"This is one of the first times in recent memory that the marketplace does not know exactly what to expect on the (Fed) announcement," said Chris Hauck, equity derivatives strategist
at Deutsche Bank. "The credit crunch is expected to add volatility to the broker/dealer earnings announcements."

Big Price Swings

Hauck looks for a sizable price swing in the shares of Lehman, the fourth-largest U.S. investment bank, when it reports earnings.

The options market is pricing in an approximate 8% move up or down in Lehman. After each of its last eight quarterly earnings announcements, Lehman has seen an average price swing of about 3%, Hauck said.

The recent turmoil in the funding markets is likely to increase volatility not only for next week's September expiration but also for the days leading up to it, said Edward Tom, co-head of Credit Suisse derivative strategy, in a note on Tuesday.

Traditionally, the difference between institutional borrow and deposit rates is reasonably tight. In June, the spread between the U.S. 3-month Libor versus Treasury Bill yields was around 40 basis points, Phil Mackintosh, also co-head of derivatives strategy at Credit Suisse, said in an interview.

But Libor borrow rates have gone up and the spread between the two has increased to around 160 basis points -- its highest level in the last 10 years, he said.

This highlights just how hard it has become to borrow money in the middle of these credit problems, he added.

"So we think the index arbitragers might try to reduce their long stock positions. It's convenient to do this on expiration day because they let the September futures expire
and sell the stock," Mackintosh said. "That would create net selling in the overall stock market on close that day, further impacting volatility."

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