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Attention Bond Bears — Opportunity Knocks

With equity volatility dormant, bonds offer an appealing options play


If I didn’t know any better, I’d say we caught the stock market dozing on the job. Sure, the S&P 500 Index has been moving a bit here and there, but realized volatility has been absolutely atrocious following the twin surges at the turn of the year.

The history books will say the bulls dominated the first two weeks of 2013 by lifting the S&P 500 Index 2.9% — and indeed they did. However, their bullish romp lasted all of about 30 minutes when the markets first open on Jan 1. Since then the S&P 500 has essentially flat-lined.

To measure the extent to which volatility is lacking, we could assess the Average True Range (ATR) or Historical Volatility (HV) of the SPDR S&P 500 Trust (NYSE:SPY). To remove any influence of the large up-gap on Jan. 2, we’ll modify the settings of both indicators to just the last eight trading sessions.

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As shown in the accompanying chart, the ATR (red line) has fallen to a paltry 84 cents, which means the daily ranges of the SPY are about the lowest they’ve been in five months.

Meanwhile, the HV (blue line) has fallen to 6%, which is also at the lower-end of its one-year range. Unless the market awakes from its daze, it’s likely both measurements could head lower.

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And yet, despite the realized volatility of the broader market being M.I.A., we’re seeing enough movement elsewhere to merit a trade or two. Take bonds. Amid the stock market snooze-fest, the iSHARES Barclays 20+ Year Treasury Bond Fund (NYSE:TLT) has been heading stealthily higher. With its short- and intermediate-term trends pointing lower, the current retracement looks to be setting up a low-risk/high-reward entry for bearish plays.

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Rather than playing the higher price, slower-moving bond ETF, traders might consider using the Proshares Ultrashort 20+ Year Treasury Fund (NYSE:TBT), which is a leveraged, inverse bond fund. The implied volatility in TBT runs about 2x hotter than TLT, so it offers options with more premium.

One higher-probability strategy worth considering is to sell the TBT February 61 put for 65 cents or better. The max reward is limited to the initial 65 cents received and will be captured if TBT remains above $61.

To minimize the risk, I suggest buying to close the put if TBT falls beneath $61. Based on a risk graph, your estimated loss would be $110.

As of this writing, Tyler Craig didn’t own any securities mentioned here.

Article printed from InvestorPlace Media,

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