Interest rate fears are beginning to take a toll on the bond market. The popular iShares Barclays 20+ Yr Treasury Bond (ETF) (NYSEARCA:TLT) has tumbled as much as 11% in the past six weeks.
The latest catalyst souring investor appetite for Treasury bonds was Friday’s hotter-than-expected employment report. The U.S. economy added 295,000 additional jobs last month, besting an expected increase of 240,000.
The reasoning goes something like this: a stronger jobs market equals improving economy; improving economy equals higher chances of inflation; higher chances of inflation equals the Federal Reserve raising interest rates sooner than later.
And since interest rates and bond prices sit on opposite sides of the teeter-totter, a rise in rates inevitably leads to a fall in bonds.
Despite the recent beating in the land of debt, bond holders did receive a slight reprieve amid yesterday’s stock swoon. As is often the case, the TLT ETF attracted some of the money fleeing from the stock market.
While the bond pop was successful in recovering some of the recent losses, it failed to reverse the trend in TLT, which remains down. Traders looking for continued weakness in bond prices over the coming weeks ought to be looking at the current rally as a selling opportunity.
Short Bonds with TLT Call Spreads
In light of the recent uptick in TLT volatility option premiums remain rich. This favors some type of option selling strategy for those attempting to capitalize on further weakness in bond prices.
Consider selling the Apr $131/$134 call spread for 42 cents or better. Think of it as a bet that TLT will be unable to climb back above $131 over the next month.
The maximum reward is limited to the initial 42-cent credit. The maximum risk is limited to the distance between strike prices minus the net credit, or $2.58, and will be lost if TLT rises above the higher strike of $134.
By risking $2.58 to make 42 cents, the high probability spread offers a potential return on investment of 16%.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
