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This morning, I am recommending a bearish trade on iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT).
Falling interest rates and fear about trade have sent investors into bonds, pushing up the price of the TLT. However, it has come up against some resistance and started heading lower in the last few days.
TLT options are still relatively cheap, and I’m expecting more short-term volatility. Now is a good time to capitalize with a downside play.
Heading Higher on Lower Interest Rates
The TLT tracks the long-term sector of the U.S. Treasury market, and generally, when interest rates fall, it heads higher.
Federal Reserve Chairman Jerome Powell has said the Fed will “act as appropriate to sustain the expansion.” That could mean another rate cut, and some investors expect the Fed to lower its target rate before 2019 ends.
If a rate cut would send the TLT higher, why look to make a bearish play? To answer that, we have to look at its daily chart.
A New 52-Week High Means New Resistance
In the last week, traders have started moving into the TLT as the stock market struggled. Escalating trade tensions between the U.S. and China and the U.S. and Mexico may have pushed traders out of stocks and into bonds. But on Monday, the TLT hit a new 52-week high at $132.58. The next day it opened lower and fell throughout the session. It could be heading lower in the short term.
Daily Chart of iShares 20+ Year Treasury Bond ETF (TLT) — Chart Source: TradingView
On the chart above, you can see the last resistance level the TLT overcame was just under $127. If that level acts as support now — and old resistance often becomes new support — the TLT might move to test that support before bouncing back toward its recent high.
As I mentioned in my recommendation on Monday, the beginning of a month is a bullish time. Also, after four weeks of corrective action, we could see a bounce in the market. If traders get bullish and move from bonds back into stocks now that a new month is starting, we could see the TLT head lower.
If that happens, we can collect profits on this downside play, which is why I’m recommending this cheap ratio put debit spread.
Using a spread order, buy to open 1 TLT Aug. 16th $128 put and sell to open 2 TLT Aug. 16th $125 puts for a net debit of about $0.15.
Note: Be sure you are opening the monthly TLT options that expire on Friday, Aug 16, 2019.
About Ratio Debit Spreads
A ratio debit spread is simply a way to lower the cost of buying options, as the two option(s) that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital and/or a margin account to execute a debit spread; contact your broker directly for specific requirements.
Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of TLT at the $125 strike price for every 1 contract that you are short of the TLT Aug. 16th $125 puts. So, this is inherently a higher risk play.
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Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.