Don’t Sell Treasuries – Sell TLT Covered Calls Instead!

by Stutland Volatility Group | December 21, 2011 8:30 am

The market yesterday provided us a major bounce, advancing 3%, which gives us a chance to put some protection on to lock in our gains.

Debt continues to be a concern in the Eurozone, with major moves in the market happening on a daily basis.  The volatility in currencies continues to be a major risk to the U.S. market.

U.S. Treasury bonds are negatively correlated to the market (i.e., trading inversely to it), and positively correlated with the U.S. dollar (i.e., trading in lockstep with it), which itself is negatively correlated to the market.

So to put protection on two fronts, we are looking to establish a buy-write position (i.e., buying the shares and selling near-term call options against them for premium) in the iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT[1]).

TLT tracks the performance of 20-year U.S. Treasuries, and now is a perfect time to put the trade on because the TLT is down more than $2.88 (2.3%).

Making the TLT Buy-Write Trade

A buy-write is simply a covered call where both positions (buying the stock and selling the option) are done at the same time.

So, first you buy TLT stock to profit from a continued rise in the dollar.  Then, we want to sell the TLT Feb 122 Calls for $3 to get a maximum amount of protection to the downside, while on the upside we are basically selling the stock out at $125 ($122 strike + $3 premium) should the TLT close above $122 in February.

The 52-week high is $125.03, so we are comfortable getting out at that level.

This is a perfect example of a trade that Stutland Volatility Group[2] puts on for its clients.  We believe that the dollar will continue to rise, which could be a risk to a portfolio of long equities.

By adding this position to a long equity portfolio, we can create yet another layer of protection to add on to a managed portfolio.  The added benefit is that this hedge could be a double winner.

If the U.S. economy can recover at the same time the dollar rallies, then we can win.  That’s yet another way SVG uses options to risk less and make more.

Here’s a quick summary of this TLT options trade:

Stock/Index: TLT

Stock Price: $120.89

Option Play: Buy-Write

Sell: Feb 122 Call @ $3

Buy: Stock $120.89

Net Cost: $117.89 ($120.89  – $3)

Breakeven: $117.89 ($120.89  – $3)

Max Profit: $4.11 (= $125 – $120.89)

Max Loss: $117.89 (= Net Cost)

  1. TLT:
  2. Stutland Volatility Group:

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