Profit From the Bond Bulls’ Misfortune

by Tyler Craig | May 30, 2013 1:40 pm

May was a devastating month for bond bulls of all stripes. The twin gravitational pull of a booming stock market and jitters over the Fed paring back its bond purchases proved too much to keep bond prices aloft.

The iShares Barclays 7-10 year Treasury Fund (IEF[1]) dropped 3% on the month, while the more interest-rate-sensitive iShares Barclays 20+ year Treasury Fund (TLT[2]) fell 6.5%. May’s swan dive was sufficient enough to drive both bond funds to new 52-week lows.

Alongside the free fall in bond prices, the 10-Year Treasury yield staged a convincing breakout to its highest levels since April 2012.

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The recent pain of bond bulls stands in stark contrast to the gains of stockholders. While bond prices actually were following stocks higher through the month of April, the relationship between these two assets quickly reverted back to a strong negative correlation in May. The relative performance of stocks vs. bonds is often viewed using the stock/bond ratio line. Simply put, when the ratio is rising, stocks are outperforming bonds,  generating superior returns for investors. When the ratio is falling, stocks are underperforming bonds.

Since bottoming in early 2009 alongside the broader equity market, the stock/bond ratio has been on the mend. The severity of this month’s bond bashing coupled with the aggressiveness in the rise of stock prices was sufficient to lift the stock/bond ratio to a new five-year high. A continued rise in the ratio suggests investors will fare better with more exposure to stocks and less exposure to bonds.

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Traders looking to profit from the misfortune of bond bulls have a handful of bond ETFs to choose from. If you’re an adrenaline junkie, though, the lack of volatility in most bond trading vehicles might be a turn off. Fortunately, there are a few leveraged bond ETFs that amp up the volatility to make things a bit more interesting.

The Proshares Ultrashort 20+ Year Treasury Fund (TBT[5]) boasts more than twice the amount of volatility as its unleveraged, non-inverse benchmark — the TLT. Plus, since TBT’s share price is down in the $60s, it offers the ability to sell naked options without an excessive margin requirement.

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With TBT residing in a short-term uptrend, you could use any type of pullback in the coming days as an opportunity to sell a July 62 put option. Provided bond prices continue their descent, the uptrend in TBT will persist, allowing the short July 62 put to expire worthless. Your max profit is limited to the initial premium received.

The 62-strike put currently is trading for 75 cents but should increase in value should we get any type of retracement in TBT this week. If bonds somehow get hoisted back up from the abyss and TBT reaches the strike price at $62, consider exiting 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/2013/05/profit-from-the-bond-bulls-misfortune/

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