I know it seems like a distant memory, but there was a time in the last year that most market participants were fairly well convinced that rates were going up. As many remember, 2013 ended with the yield on the 10 year U.S. Treasury at 3%, a level not seen since mid 2011, and between $1 and $2 billion of bond purchases ago from the U.S. Fed:
For some reason, 3% seems like a fairly interesting technical and psychological level for traders/investors. In the face of the FOMC’s last statement suggesting that QE would be wound down in October, rates continue to trickle lower, testing 1 year lows.
Throughout the supposed economic recovery of the last few years, there have been fits and starts where high yielding sectors like Utilities and REITS have dramatically outperformed more cyclical sectors, largely due to investors demand for yield. Verizon is a stock that we have owned in the past, most recently this spring when it was nearly 10% lower than current levels (from Feb 14th: VZ: Can You Buy Me Now). While our bullish thesis had less do with the company’s fundamentals, it had much to do with their domestic revenue exposure, and then 5% dividend yield. It was a sort of Fortress America trade with the Fed’s continued commitment to keep rates low and thus making stocks like VZ with their yield more attractive.
VZ shares are now approaching the prior 52 week high at $52, and looking a tad extended:
Back in February when we bought the stock, we also sold a call creating a buy-write, which looked like an attractive way to add about 1% yield as implied volatility (the price of options) was hitting multi-year highs:
What is fairly glaring from the chart above is that as stock marched towards 52 week highs, the price of options was cut in half, making vol sales unattractive, and possibly making leverage, stock replacement or risk management structures with long premium trades very attractive.
As we get closer to the end of the TAPER, bond proxies like VZ could see a a reversal of fortune as they have become a fairly crowded trade.
For those looking to maintain longs, and their exposure to a 4% plus yield, targeting cheap put protection could be a way to stay in the game and hold onto hard fought gains. For those looking to take profits off of the table, but think other investors may flock to the stock/sector if rates don’t go up, despite the Taper, one way would be to buy cheap calls or call spreads. And for those who are thinking that VZ is set to breakout, that the market does not think rates move higher any time soon, and bond proxies will continue to out perform then adding calls, call spreads or ratios to longs could add considerable leverage.