Bearish on Bonds Reaching New Highs?

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While bond prices remain firmly entrenched in a longer-term uptrend, prices have leveled off in recent months.

As evidenced in the iShares Barclays 20+ Year Treasury Fund (NYSE:TLT) chart below, price movements have adopted more of a neutral tone following the epic rally in August and September.

Concurrent with the sell-off in stocks this week, money shifted into the bond market — causing the TLT to rally 4% as of Wednesday’s close.


Source:  MachTrader

Traders believing that bond prices will fail to rally to new highs over the next month may consider using the current rise in the TLT as an opportunity to sell out-of-the-money call spreads.

Short call spreads, sometimes referred to as bear-call spreads, offer a high-probability way to bet the price of a stock will either stagnate, drop, or even drift higher by a small amount.  Though the potential risk will far exceed the potential reward in this trade, the higher probability of profit makes the lopsided risk-versus-reward ratio acceptable.

Suppose you believe TLT will remain below $126 by January expiration.  To profit from this expectation, you could enter the TLTJan 126-131 bear-call spread by selling to open the $126 call for 93 cents (credit) and buying to open the $131 call for 31 cents (debit).

The net credit received at trade inception is 62 cents, which represents the maximum potential reward that you will capture if TLT remains below $126. The max risk is limited to the distance between strike prices minus the net credit ($5 – 62 cents), or $4.48.  You will incur the max loss only if TLT rises north of $131 by January expiration.

At the time of this writing Tyler Craig had no positions on TLT.

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Article printed from InvestorPlace Media, https://investorplace.com/2011/12/bearish-on-bonds-reaching-new-highs/.

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