Fade the Bond Boom With the TLT ETF

Bond prices have kicked off 2015 with a bang. The popular iShares 20+ Year Treasury Bond ETF (TLT) has rallied as much as 5.2% thus far and we’re a mere three trading days into the year. Such a torrid pace is anything but sustainable, so I suspect mean reversion will exert its inescapable influence sooner than later.

This week’s surge has added to last year’s gargantuan 24% gain in TLT, briefly driving the fund into previously untouched territory. I recall much speculation that the 2012 peak in bond prices — and corresponding low in bond yields — may have been a multiyear (if not multidecade) inflection point for bonds.

That particular forecast was proven woefully wrong Tuesday as TLT climbed to a new all-time high intraday.

While the uptrend in the TLT ETF is incredibly strong, the recent rise has reached the parabolic stage. The current posture of TLT reminds me of mid-October when the extremely overbought conditions in the bond ETF finally succumbed to gravity.

Just like that autumn episode, the current spike in TLT is occurring on higher-than-average volume.

iShares Barclays 20+ Yr Treas.Bond (ETF)
Click to Enlarge
Source: MachTrader

How to Trade the Bond Spike With TLT Options

The surge in bond prices has been met by an equally sharp rise in demand for option contracts on TLT. The elevated demand has driven implied volatility on TLT options to the 76th percentile of its one-year range. Simply put, option premiums have become elevated in the bond fund and are now much more attractive to sell.

Traders anticipating a pullback in the TLT ETF could exploit the potentially overpriced options by selling a Jan $135/$140 bear call spread for 50 cents or better. Consider it a bet TLT resides below $135 by the fourth Friday of January.

The reward is limited to the initial 50-cent credit and will be captured provided the call options sit out-of-the-money at expiration. The risk is limited to the distance between strike prices minus the initial credit, or $4.50.

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

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