The degree to which last week’s poor employment report spooked the markets is perhaps best illustrated by the enormous surge in the popular iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT). Friday’s flight to safety led to a 2% jump in TLT, driving it to extreme heights in the short run. Alongside soaring bond prices, the 10-year bond yield fell to its lowest levels of the year at 1.69%.
Click to Enlarge To capture just how overbought TLT has become, I’ve plotted a Bollinger Band study set at three standard deviations. Over the past few years, it’s been rare to see TLT venture outside the three sigma bands. Yet with Friday’s up-gap, it did just that.
While the bond fund could continue higher from current prices, it’s much more likely we see it mean-revert or tread sideways to work off the overbought conditions.
Click to Enlarge Candlestick analysis helps add color to our short-term outlook. Friday’s trading session ended with an exhausted-looking shooting star candle. Not surprisingly, the candlestick looks just like its name — a shooting star. It has a small body at the lower end of its range with a long upper shadow. When the candle forms after a multi-candle upswing — as it has in TLT — it often indicates a pullback is imminent.
At a minimum, the current posture of TLT makes bullish plays unattractive. If you think the uptrend in bond prices is going to return with a vengeance, at least wait for a better risk-reward entry. A pullback or some consolidation will develop just such a setup.
On the flipside, if you’re willing to bet TLT falls back from its lofty heights, you could consider buying a May 123-120 bear put spread for $1.50 or better. The max risk is limited to the initial $1.50 paid and will be lost if TLT is above $123 at expiration. The max reward is the distance between strikes minus the initial debit, or $1.50, and will be captured if TLT sits below $121 at expiration.
To minimize the loss, you could exit the spread if TLT breaks above Friday’s high of $123.45.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.