The ongoing market fear fest is driving assets into safe harbors like Treasury bonds. Over the past week, the iShares 20+ Year Treasury Bond ETF (TLT) has climbed as much as 4% on heavy volume, setting up an attractive opportunity for those willing to step in and fade the fear.
Despite the nascent rebound, the TLT ETF remains in an overall downtrend. Such has been the case all year, really. Take note of its declining 50-day moving average and the series of lower pivot highs carved out over the past six months.
While the current rally may persist for a while yet, I suspect it possesses the same destiny as all the others: failure.
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On the options front, things have been hoppin’. Fears of higher interest rates combined with the ongoing market turmoil have driven implied volatility for TLT options sky-high again. Inflated option prices are just the ticket for the option sellers among us — they boost the premium received, which delivers a better return on investment. The current IV rank is 83%.
Additionally, TLT options are exhibiting upside volatility skew, where out-of-the-money calls are trading at higher implied volatility levels than out-of-the-money puts. The lopsided pricing is a function of the elevated demand for calls we’ve seen of late as scared money floods into bullish bets on bonds.
Traders willing to fade the fear can exploit the both the high IV rank as well as the volatility skew in upside calls by selling bear call spreads.
TLT Options Trade
Sell the Aug $125/$130 call spread for a credit of 60 cents. Consider it a bet that TLT sits below $125 by the time August expiration rolls around.
The reward is limited to the initial 60-cent credit and will be captured if the call options expire out-of-the-money.
The risk is limited to the distance between strikes minus the net credit, or $4.40, and will be lost if the bond ETF rises above $130.
As of this writing, Tyler Craig owned short call spreads and short put spreads on TLT.
