Trade Update – TLT: Closing June Call Fly for a Loss

by Dan June 4, 2015 2:49 pm • Commentary

A little more than 2 weeks ago, we expressed a near term bullish view in U.S. Treasuries when the 30 Year Bond etf (TLT) was trading $121 (below), a little less than 2% from where it is trading now. To refresh:  

Trade: TLT ($121) Buy June 120/125/130 Call Fly for 1.25

Since May 15th Treasuries have been volatile to say the least. Over the last 15 trading days the TLT has traded as high as $123.50 and as low as $117.10, kind of a large range for a Treasury bond etf:

[caption id="attachment_54214" align="aligncenter" width="600"]TLT 15 day chart from Bloomberg TLT 15 day chart from Bloomberg[/caption]

Before the open tomorrow we will get the May unemployment data. Right now the out of the money fly is benefiting from the uncertainty as implied vol in TLT is higher.

Your guess is as good as mine how stocks and bonds react to the jobs data. A hot number would suggest that the Fed will raise the Fed Funds rate, possibly as soon as September. That has the potential to send stocks and bonds reeling. But if the data is weak, suggesting a push out of rate increases (possibly until 2016 and as was urged by the IMF this morning) then we could see stocks and treasuries rally.

But again, who knows if bad news for the economy is good news for stocks and to be frank bonds could be doing there own thing at this point regardless of the data.  At this point the set up could be sort of is binary for my TLT trade and I think it makes sense to salvage what premium I can. The trade is a small loser now and could be randomly better or worse at the open tomorrow but with vol likely lower following the jobs data, if it’s out of the money still (below 120, it gets hit even if it goes sideways or slighly higher)

Action: Sell to Close TLT ($119.20) June 120/125/130 Call Fly at .85 for a .40 loss




Original Post May 15, 2015: New Trade – $TLT: Bond Villain

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:

TLT 1yr chart from Bloomberg
TLT 1yr chart from Bloomberg

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:

TLT 2yr chart of 30 day at the money implied vol from Bloomberg
TLT 2yr chart of 30 day at the money implied vol from Bloomberg

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.