Bond prices have been more resilient than most estimates. The consensus was that in a tightening rate cycle from the Federal Reserve, treasury prices should fall. But that has not happened as evidenced by the strength of the iShares Barclays 20+ Yr Treas.Bond (ETF) (NASDAQ:TLT).
There is so much global interference by all central banks and especially Europe that the usual impact on treasury prices is not happening. Instead, we are trading inside of predictable ranges. Back in March, I shared a winning bullish TLT trade that really marked the start of a 10% rally with more upside potential still possible.
Today, I want to essentially rinse and repeat what I did back then. But since I am realistic with my expectations I will not be chasing prices higher. Rather, I will create income out of thin air betting that the TLT proven support will continue to hold through 2017.
Click to Enlarge Fundamentally, the TLT should continue to benefit from upside pressure from the actions of central banks outside of the U.S., especially the ECB. Global investors who seek bonds are forced into the U.S. Treasuries for better returns or to avoid the ridiculous situations of negative rates.
I have to recognize that my trade would be vulnerable to Draghi rhetoric. So far he has been posturing for tapering their QE efforts in Europe but his actions are contradictory to that notion.
But he is unpredictable and if he suddenly announces that the easy money is about to end in Europe then there will likely be money chasing that market instead of the TLT. Until then — T.I.N.A. That is, “there is no alternative” remains in effect, thereby propping up the TLT.
I have to recognize that my trade would be vulnerable to Draghi rhetoric. So far he has been posturing for tapering their QE efforts in Europe but his actions are contradictory to that notion.
But he is unpredictable and if he suddenly announces that the easy money is about to end in Europe then there will likely be money chasing that market instead of the TLT. Until then — T.I.N.A. That is, “there is no alternative” remains in effect thereby propping up the TLT.
Bond experts have been wrong for years about bonds price levels and I Bet that they will be wrong again. So I sell risk against extreme opinions for income.
The Bet: Sell TLT Dec $118 put and collect 50 cents per contract to open. This is a bullish trade that offers me an 85% theoretical chance that price will stay above my strike. Otherwise, I own shares of TLT and accrue losses below $117.5.
To balance my risk, I can sell upside risk as a hedge.
The Hedge (Optional): Sell Dec TLT $135 call for 60 cents where I also have an 85% chance of success. All I need is for TLT to stay below my call to win. Else I am short at $135 and would accrue losses for as long as TLT can rally.
By taking the bullish and the bearish setups I would need price to stay between $135 and $118 2017 to retain maximum gains. My breakeven points are $117 and $136.10.
To mitigate the risk associated with selling naked options I can sell spreads instead. There the maximum risk is limited by the width of the spread.
The Alternate Bets: Sell TLT Dec $119/$118 credit put spread and the $134/$135 credit call spread. I have about the same odds of success. Then they would yield 30% on money risked.
Investing in the stock market never comes with guarantees. That’s why I never risk more than I can afford to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
