Back on Jan 16th (TLT: No Mr. Bond, I Expect You To Die) I had the following to say about the rally in Treasury Bonds;
It is our sense that the U.S. Treasury rally is getting long in the tooth, despite the growing uncertainty in global growth, the surge in the dollar, the crash in industrial commodities and the erratic behavior by a growing number of central banks. It’s our view that we could be near a period of moderation of Treasury bond demand as we get closer to the ECB’s much anticipated January 22nd meeting and likely decision to get into the QE game. And I’ll take it a step further, with the next FOMC meeting on Jan 28th, I doubt there will be too many surprises from last weeks minutes of the December meeting, but following meeting on March 18th could be the one where the Fed strikes a more hawkish tone If in the meantime we were to get a continuation of better jobs data (with some wage growth) here in the U.S., improving manufacturing data, stabilization of commodity prices and the slightest bit of inflation, the talk prior to the March meeting will once again turn to how soon the Fed can raise. Obviously this will not be good for treasuries.
Flash forward four months, and the TLT is down 10% from that post, and 13% from the 52 week highs. The Fed in fact did not become more hawkish explicitly, but the market moved ahead of them anyway. And while the set up to short bonds in January was fairly compelling, the opposite could be true for a trade on the long side prior to the FOMC’s June 17th meeting. Aside from some OK employment data, most economic data here is the U.S. has been disappointing highlighted just this week by Wednesday’s weak April retail sales report, this morning’s weaker than expected Empire Manufacturing data for the first half of May and the big miss in Consumer Confidence. Not only is the Fed not raising in June, but if Q2 GDP continues to track the weakness of Q1 without the cold rain and snow, then rate increases could be off the table for the balance of the year, and the recent rise if yields could quickly be reversed.
It seems like everyone has become an expert of late in the direction of interest rates and of the technicals of the TLT, so how could I not get in the game? This week’s low was essentially exactly where it should have been, and a close today above $120 could be the start of a stabilization:
As was the case in January when we last traded TLT, the movement in the underlying has caused options prices to be elevated, especially relative to its equity brethren, with 30 day at the money implied vol up a couple points in the last coupe weeks, nearing the 52 week and 2 year highs:
Elevated options prices are making long premium directional plays challenging.
The trade I want to do looks to offset some of the high vol through its structure and the fact that it is in the money.
Trade: TLT ($121) Buy June 120/125/130 Call Fly for 1.25
-Buy 1 June 120 call for 2.80
-Sell 2 June 125 calls at .90 each or 1.80 total
-Buy 1 June 130 call for .25
Break-Even on June Expiration:
Profits: up to 3.75 between 121.25 and 128.75 with max gain of 3.75 at 125
Losses: up to 1.25 between 120 and 121.25 & between 128.75 and 130 with max loss of 1.25 below 1.25 and above 130
Rationale: The idea here is to stop this trade at this weeks low down near 119, but to catch the potential for a sort of mean reversion trade back to the mid point of the 6 week range in front of a potentially market moving event the week of expiration in the form of the FOMC meeting.