The recent selling frenzy in the equities market and subsequent rush of capital into bonds has made a mess of what was otherwise becoming a beautiful bearish trend reversal in the iShares Barclays 20+ Year Treasury Fund (NYSE:TLT). As outlined in Advance in Bonds a Sucker’s Rally?, the TLT had formed a textbook rounded top and high volume breakdown, signaling its reversal into an intermediate downtrend.
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To exploit a continued move to the downside, I suggested selling a May 116-121 call spread for a net credit around 94 cents.
Unfortunately, the aforementioned flight to quality has reversed the breakdown and propelled the TLT back above its 50-day moving average. Not surprisingly, the May call spread has increased in value to $1.24 causing anyone who sold it for 94 cents to be sitting with an unrealized loss of 30 cents. The question of the day, then, is whether or not traders should sit tight, exit, or make some type of adjustment.
Suppose we want to reduce our exposure while still maintaining some type of bet that TLT will be hesitant to move much higher from current prices. An adjustment called “rolling up” will do the trick.
The technique involves nothing more than closing the current May 116/121 call spread at $1.24 while opening up a new call spread with higher strike prices, such as the May 119/124 for 54 cents per spread (selling the 119 strike and buying the 124 strike).
Though closing the existing spread will lock-in the 30-cent loss, the new call spread offers the ability to recoup the loss plus a small profit if TLT remains below $119 by May expiration. By rolling up the short strike from $116 to $119, we’ve allowed the position more breathing room in the coming weeks. Additionally, the overall delta of the position has been reduced so that losses will accumulate at a slower rate if TLT continues to rise.
Lest you think “rolling” is a magic band-aid that can fix any vertical spread trade, keep in mind you will lose more money if TLT doesn’t cooperate. Before employing this tactic, make sure you’re comfortable with the new position and your outlook remains the same.
And remember, sometimes simply exiting losing trades is the best course of action.
At the time of this writing, Tyler Craig had no positions on TLT.
