My notion of risk was not limited to directional risk though. After seeing the two distributions above, my initial idea was precisely that CME traders were buying volatility (the “straddle” on the numbers) and thus overpricing the tails. But this does not seem to be borne-out by the data (which I haven’t seen myself.) In these auctions, buying one outcome is a sell of all other outcomes, which helps explain who is supplying the wings.

Although the CME exchanges are far too small, and so poorly designed that no one takes them seriously, in theory if you had enough time to waste attempting to do an odd lot on the contract..

One would compare it and trade it against the OTM probabilities on the FED FUND futures options.. which is where the real risk transfer takes place..

No body has risk to the Non Farm Payroll number per se, they have risk as far as that number is an input into the Central Banks forecast and more importantly the perception that the market has of that forecast.. (a la Keynesian beauty contest)

You should ask yourself who rationally will sell the wings of those NON FARM payroll trades?

Other than my uncle sitting in Florida trading an odd lot and watching CNBC.. only someone who can convince himself that he has an offsetting hedge…

Yesterday’s ISM number was a good example.. within seconds of that numbers realease.. (forgetting the 15 minute leak).. the probability of the FED easing by January essentially doubled…

Out of the money calls quadrupled in value and more…
The key is weighting.. the mapping should be.. (assuming infinite wisdom) what will be the change in probabilities for a given number..

This week has been trivial.. and more so because by now the game is so well established at least in probability terms that it has its own “rulebook”… with live commentary on Bloomberg .. and referees from the Federal Reserve Bank.. who actually comment directly on the “bets” being made in both the Fed Funds and Fed Funds options marketplaces.. (see Donald Kohn..William Poole..and Janet Yelling [who actually integrates the Case/Shiller Prediction market projects into FED Forecasts])

For the last weeks the Bet is/was… how likely is the FED to change its Bias at the December FOMC meeting.. not ease or tighten but to change their revealed “forecast”..

This meta event, should it happen, would of course imply a change in the expectations that the next FED move would be an EASE and if the bias Statement comes in December, by definition the probability of a move increases ex ante at the January FOMC…
raising form zero percent where it was to X%..

As a side note.. this has nothing of course to do with the question as to whether the FED will actually EASE or not in March… a) you’ll know the answer to this.. on December 12th,
b) actually doesn’t have much to do with whether the FED will ease in January either..

Just like Keynesian Beauty contest.. its a question of how many levels of backwards induction you want to run.. there is now a market convention..

If the ISM was below 50%.. etc. etc.. the probability that the FED would change the bias..would be say 50%.. too.. An Easing bias is modeling rationally at implying 50/50 odds that the FED will EASE in the future.. i.e half way between on hold and ease..

So not surprisingly on the number the probability of the FED easing by January moved to around 25%… or 1/2 way to 50%.. which is where it will be if the FED shifts their bias..

In a Bayesian World the key is can one map ex ante a given economic data point to a change in expectations..

Sometimes the number is relevant and sometimes its not..
Post the massive revisions in Non Farm Payrolls for the time being nobody is paying much attention to them..

Even algorithmic traders now now you have to read the caveats to figure out whats what.. and once you do that the data is meaningless..