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Bear Spreads on Bonds Worth Another Shot

Make quick returns (again) with another TLT option trade


In the world of charts and fundamental data about stocks and companies, you have access to numerous methods of identifying actionable trade opportunities. You might elect to trade the same securities over and over and over again, once you figure out their rhythm.  Like mama’s home cooking, it’s sometimes a great idea to find comfort and familiarity in sticking with what you know.

As you become “tuned in” to a stock’s personality, you can often acquire an edge in forecasting its future. This approach appeals especially to those with an eye toward simplicity. You wake up each morning knowing precisely what securities you will be trading. This frees up additional time to allocate toward trade and risk management.

Here’s an example of this approach in action.

In our December post titled Bearish on Bonds Reaching New Highs? we suggested selling a January 126-131 bear-call spread on the iShares Barclays 20+ Year Treasury Fund (NYSE:TLT) for a net credit of 62 cents ($62 per contract).  With the spread now worth a mere 10 cents ($10 per contract), the majority of the profit has been captured.

In a bear-call spread, you “sell to open” the lower strike ($126) and “buy to open” the higher strike ($131) to collect a net credit. In doing so, you are looking for the spread to decline in value so that you can close out the trade either by buying it back for less than you collected to enter it, or letting it expire worthless.

So now, rather than casting off TLT in search of a new trade, how about entering another bear-call spread on this bond ETF for February?  Provided our outlook on TLT remains the same as last month, it makes sense to re-enter a similar trade for this month.

As evident in the chart below, TLT remains in a sideways trend.  To exploit this type of price action, you could sell a TLT February 124-129 call spread by simultaneously “selling to open” the $124 call option and “buying to open” the $129 call option for a net credit around 65 cents.

Source:  MachTrader

In doing so, it doesn’t matter exactly how much you collect for the option you sell or what you pay for the option you buy, as long as you pocket at least 65 cents on the trade in its entirety.

If TLT fails to rise above $124 by February expiration, you stand to gain the entire $65 (65 cents x 100).  The max risk is limited to the distance between the strikes ($129 – $124 = $5 x $100 = $500) minus the net credit, or $435.

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