Bond Prices Are Stabilizing — Profit Via TLT

by Tyler Craig | October 2, 2013 11:53 am

The market gods have taken pity on beleaguered bond bulls and gifted them with a refreshing respite from their painful plight. While the recent bond rebound is likely temporary, it does provide an alluring opportunity — via the iShares 20+ Year Treasury Bond Fund (TLT[1]) — for tactical traders looking to trade in and out of what will likely be a prolonged southbound slide for the toppy asset class.

The bearish long-term thesis[2] we recently laid out, as well as the bullish short-term thesis[3], remain intact. However, the suggested strategy for exploiting the recent bond bounce has played itself out.

With October expiration looming and the 100-95 put spread having fallen to a lowly 5 cents, the lion’s share of the profit has been captured. It appears it’s time to head back to the well to draw out yet more greenbacks from the TLT.

But first, let’s make the case for why its about-face might have staying power:

TLT Technicals

After carving out a classic double-bottom, TLT has risen back above its 50-day moving average for the first time since May. The duration of its nascent ascension has been sufficient to turn the 20-day moving average higher, adding confirmation that the short-term trend is indeed up.

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At the same time, 10-year Treasury yields (TNX[4]) have fallen well below support and remain under pressure at 2.6%. Since bond yields and prices have an inverse relationship, continued weakness in TNX should buoy TLT.

Click to Enlarge

Finally, growing jitters over the government shutdown should keep stock volatility high and investors aplenty quick to run into Treasuries for safety if things turn really sour.

Scared money and bond bulls are fast friends.

To exploit continued stability in TLT, sell the Nov 102-98 put spread for 48 cents credit. The max reward is limited to the initial credit received, and the max risk is limited to the distance between strikes minus the net credit, or $3.52.

To reduce the risk, consider closing the spread if TLT tumbles back below double-bottom support around $102.

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

  1. TLT:
  2. bearish long-term thesis:
  3. bullish short-term thesis:
  4. TNX:

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