Holy bond bloodbath, Batman! Screams of “higher rates, higher rates” echoed throughout the bond market yesterday as investors ran for the exit doors en mass.
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The go-to proxy for long-term treasury bonds — the iShares Barclays 20+ Yr Treas.Bond (ETF) (NASDAQ:TLT) — plunged 4.2% the day after Election Day and is meandering on Thursday. Not only is Donald Trump our new president, he may have just kicked off the long foretold bond bear market.
Fortunately for traders, volatility is bound to hound TLT for the foreseeable future. And therein lies opportunity.
Whether this downturn goes the distance (we’ve had many false starts in recent years) remains to be seen. But with inflation pressures on the rise, and a President-elect boasting of big-time fiscal spending plans, the odds of bond yields having bottomed (and thus bond prices having topped) is elevated.
The TLT ETF is heading southbound in a hurry. With yesterday’s destruction, this bond ETF sits well below all major moving averages. The peak-to-trough drop has now reached 14% placing the long bond a stone’s throw away from bear market territory.
It’s worth noting the volume accompanying Wednesday’s dive was enormous. This wasn’t a few disgruntled bond lovers abandoning ship. Rather, it was an institutional-driven exodus by large players fleeing the specter of higher rates.
The TLT ETF Bond Trade
With all this bearish talk you would think a short TLT play would be in the offing. But it’s not. Chasing bonds after such an outlier drop certainly isn’t exactly a low-risk setup. If you want to join bond bears, pray to the market gods for some type of rebound so you can initiate your shorts from higher levels.
The depth and volume of the descent have my inner contrarian growling. The selling may be a bit overdone in the short run plus implied volatility has ramped making option premiums juicy for selling. If you think bonds are able to muster together an oversold bounce in the weeks ahead, sell the Dec $118/$114 bull put spread for 42 cents.
If the TLT ETF sits above $118 at expiration you’ll capture the 42 cent premium. The risk is limited to the distance between strikes minus the net credit, or $3.58, and will be lost if TLT tumbles below $114. I suggest bailing if prices breach $118.
Finally, in timing the entry, wait for an up day or some signs bond prices are stabilizing. It may be a day or two before a pivot low forms.
As of this writing, Tyler Craig owned bearish trades on TLT.
