Bond Bloodbath Merits a Put Spread Roll

by Tyler Craig | August 20, 2012 9:01 am

The euphoric rise in U.S. equities during the past few weeks has been matched by an equally impressive fall in bond prices. While it’s not altogether surprising that these two assets moved in opposite directions — they do, after all, have a strong negative correlation — it is interesting to note how swiftly money has fled the bond market. Particularly since bonds have been so reticent to fall from their lofty heights during other such recent upturns in stocks.

Click to Enlarge As a result of the continued exodus from bonds, the Sep 120-115 bull put spread on iShares Barclays 20+ Year Treasury Fund (NYSE:TLT[1]) suggested in my recent post on bonds (It’s Hammer Time for Bonds[2]) has taken a turn for the worse. At the time of the original article, the spread could have been entered for a 62-cent credit. With the position currently valued at $1.26, traders are losing 64 cents.

Although we find ourselves in a rather troublesome predicament, it does provide an opportunity to illustrate a trade adjustment for bull put spreads that run amiss. The adjustment technique is referred to as “rolling down.” It consists of closing the initial position and opening up a new bull put spread with lower strike prices.

For example, traders could close the Sep 120-115 put spread and open a Sep 118-113 put spread for a 73-cent credit. In the event TLT sits above $118 at September expiration, the profit from the new put spread would recoup the 64-cent loss, plus an additional 9-cent profit.

The rolling-down technique provides two primary benefits:

1. Improved probability of profit: By moving the short strike price from 120 to 118, the TLT only needs to remain above $118 by expiration for you to capture the profit on the new spread.
2. Lower directional risk: The net delta of the 120-115 put spread is +27, which means that for every $1 drop in TLT, the spread would lose $27 in value. With a lower net delta of +19, the new 118-113 put spread will accumulate losses at a slower pace if TLT continues to fall.

Of course, by rolling down the put spread, traders do run the risk of adding insult to injury by racking up additional losses in the new position. In the event you’re no longer bullish enough on TLT to warrant owning a bull put spread, consider closing the position outright to minimize the loss.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2012/08/bond-bloodbath-merits-a-put-spread-roll-tlt/

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