Here’s an Interesting Trade
Call me a wimp for going so deep in the money on this trade and chasing such a small profit on my new position in the iShares Barclays 20+ Year Treasury Bond Fund (TLT) November, 2017 $129-$131 in-the-money vertical BEAR PUT spread yesterday.
With my Market Timing Index close to an all-time high at 83, and risk assets enormously overextended, I am not inclined to bet the ranch here.
However, let’s say you are a much more aggressive person than I am, and are not only willing to bet the ranch, but also swing for the fences, go pedal to the metal, and have the cajones to do it.
Well, do I have a trade for you!
Does a 100% return in six months pique your fancy?
The fundamental reasons for this trade, which has been writing me a check almost every month this year, are just as good as ever.
1) The global synchronized recovery is accelerating.
2) Fed governor Janet Yellen plans to start dropping on the bond market in the very near future $6 billion a month, or $200 million a day, worth of paper in her QE unwind.
3) It is widely perceived that potential tax cuts will provide further stimulus for the US economy.
4) The Fed is expected to RAISE interest rates 25 basis points every quarter for the next five quarters to normalize interest rates.
5) These successive rate hikes will produce an inverted yield curve by the end of 2018, whereby short term interest rates are HIGHER than long term ones.
Needless to say, all these prospective issues are HUGELY bond negative.
In fact, they justify a much more aggressive trade of the sort I have been recently recommending.
Here is what these circumstances truly deserve:
Buy the iShares Barclays 20+ Year Treasury Bond Fund (TLT) March, 2018 $123-$125 in-the-money vertical BEAR PUT spread for $1.00.
This is a bet that the (TLT) will be trading BELOW $123 by the March 16, 2018 options expiration, compared to today’s $125.69.
The (TLT) only has to fall $2.69 in six month for you to gain a 100% profit on this trade. And it has the five massive tailwinds I described above to help accomplish this.
For that to happen the ten year Treasury bond yield would only have to move ABOVE 2.40% in six months, from the current 2.30%. Yes, get a home run by only scoring a 10 basis point move in the bond market.
That is an enormous return for such a minimal assumption.
There ARE a couple of provisos to this positon.
If the (TLT) trades above $125 at the March 17, 2018 expiration you will lose your entire investment.
So, maybe you don’t want to bet the entire ranch, maybe only the back 40.
For that to happen we would have to get a major geopolitical event, like war with North Korea, or an out-of-the-blue recession, either of which would send bonds rocketing.
So there’s your bet.
These options are also illiquid. So don’t be surprised to place an order to buy at $1.00, see it trade all day at $0.95, and nothing gets done.
Such is the inefficiency of an options market that attempts to simultaneously execute over 11 different electronic exchanges.
The best way to deal with this is the split your order into four pieces and place four different orders at different prices on both sides of the middle market price.
If you don’t do options, this would be a great level to scale into a long in the ProShares Ultra Short 20+ Treasury Bond Fund (TBT), a bet that bonds will fall.
However, since this is an ETF and not an option position, you won’t have time decay working in your favor. But it won’t go to zero either.
Here are the specific trades you need to execute for a $10,000 position:
Buy 100 March 17, 2018 (TLT) $125 puts at……………………..$3.50
Sell short 100 March 17, 2018 (TLT) $123 puts at………………………..$2.50
Potential Profit: $2.00 – $1.00 = $1.00
(100 X 100 X $1.00) = $10,000 or 100% in 248 days.