Is a Bond Rebound Looming?

by Tyler Craig | March 8, 2013 11:22 am

The latest surge in stocks was driven by Friday’s better-than-expected employment report. Job creation swelled in February[1], leading to 236,000 new jobs and a drop in the unemployment rate from 7.9% to 7.7%. The SPDR S&P 500 ETF (NYSE:SPY[2]) gifted traders with yet another price increase, gapping higher by 0.68%. However, with the SPY already up five days in a row, many traders used the up-gap as an opportunity to take profits.

As stocks have continued to recover from February’s 3% selloff, U.S. Treasury bonds have once again fallen out of favor. As of Friday’s open, the iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT[3]) was down 3.4% on the week. While the trend of TLT remains decisively down, the most recent bout of selling has driven the bond fund to what may be a short-term price extreme.

Click to Enlarge
The accompanying chart displays the TLT with the popular technical indicator — Bollinger bands. The Bollinger band study is an adaptive volatility envelope that expands and contracts based on the underlying movement of the stock. In times of high volatility, the bands widen. In times of low volatility, the bands narrow.

Among other things, the bands are designed to identify price extremes, which often act as short-term turning points for the stock. When a stock ventures outside the bands, it often snaps back in the opposite direction.

As shown in the chart, TLT has once again reached the lower band, making this a logical area to take profits on bearish trades and perhaps consider a contrarian bullish play.

Traders looking for a rebound in TLT — or at least some consolidation in the coming weeks — could sell the April 111-106 bull put spread for 50 cents in credit. The spread is entered by selling the April 111 put and buying the April 106 put. Consider the strategy a bet that TLT will remain above $111 by April expiration. If it does, the puts will remain out-of-the-money and expire worthless thereby allowing you to pocket the 50-cent profit.

The max loss is capped at $4.50, or the distance between the strike prices minus the initial credit. To reduce the risk, you could close the position if TLT falls below $111.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. Job creation swelled in February:
  2. SPY:
  3. TLT:

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