The climb in interest rates rolls on this week. With today’s jump the 10-year treasury yield is once again closing in on a new nine-month high near 2.5%.
Whether or not this is the beginning of a prolonged regime of rising rates remains to be seen, but traders who have been positioned for such an outcome are certainly enjoying their day in the sun.
All told, 10-year yields have gained 46% since bottoming in late January.
Meanwhile, bond prices have been tumbling. While the iShares 7-10 Year Treasury Bond (IEF) is down a mere 5% over the same time frame, the hyper-rate sensitive iShares 20+ Year Treasury Bond (TLT) is down 15%.
Not surprisingly, the ongoing strength in yields has taken its toll on rate-sensitive areas in stock land as well.
The iShares U.S. Real Estate ETF (IYR) is 11% off its highs. The Utilities Select Sector SPDR (ETF) (XLU) is down 15%.
The easiest, and arguably most attractive, way to get it on the action in interest rates is using the aforementioned TLT ETF. Of all the bond funds, TLT is the most liquid. It’s averaging just shy of 10 million shares in daily trading volume and boasts options with tight bid-ask spreads. It also offers more volatility than IEF resulting in more opportunity for tactical traders.
Just remember bond funds like TLT move inverse to interest rates so if you’re bullish on treasury yields then enter bearish plays on TLT and vice versa.
In light of the elevated anxiety surrounding bond prices and yields, the implied volatility for TLT options is running hot. Which is to say, they’re expensive and quite a bit more attractive to sell these days than options on, say, the dull stock market.
Rather than piling on the bullish interest rates wagon I’d suggest a more tempered approach here. Chasing treasury yields after they’ve risen so far in the past hasn’t been a good idea. But that doesn’t mean we have to necessarily bet rates are going to fall aggressively from here either.
The play I like the most is to bet on some digestion or sideways price movement in yields — and therefore bond prices — over the near term. We can sell an iron condor in TLT to exploit both the expected price range and the overpriced options.
Sell the Jul $112/$108 bull put spread for 35 cents and sell the Jul $121/$125 call spread for 32 cents.
The maximum reward is limited to the initial 67-cent credit and will be captured if TLT can remain between $112 and $121.
The maximum risk is limited to the distance between strikes minus the net credit, or $3.33, and will be lost if TLT either rises above $125 or falls below $108.
At the time of this writing Tyler Craig owned iron condors on TLT.
