MorningWord 11/19/15: $TLT – Surety Bonds

by Dan November 19, 2015 9:25 am • Commentary

Yesterday’s price action in U.S. stocks following the release of the October FOMC meeting minutes suggests, at least for now, that equity investors are comfortable with the notion of a rate increase at their Dec 16th meeting. It was also interesting that U.S. Treasury yields did not budge on the news, basically closing flat on the day.

The iShares 20 year Treasury Bond etf (TLT) is bid up small in the pre-market as I write.  And since the FOMC’s Oct meeting (when expectations of a December liftoff, lifted off) the yield on the Treasury bond has risen about the amount that the Fed is expected to raise next month:

10 year Treasury bond yield, 1yr chart from Bloomberg
10 year Treasury bond yield, 1yr chart from Bloomberg

Its also interesting to note that at about 2.25%, the 10 year yield is about the midpoint of the 4 year range of 1.5% and 3%:

10 year Treasury yield, 4 year chart from Bloomberg
10 year Treasury yield, 4 year chart from Bloomberg

Looking at implied volatility for short dated options in the TLT, options are pricing in less and less expected movement in the underlying, with iv 30% below the 52 week highs and just one point off of the 2015 lows:

TLT ytd chart of 30 day at the money implied volatility from Bloomberg
TLT ytd chart of 30 day at the money implied volatility from Bloomberg

Despite lower implied vol, the options market is still implying a nearly a 3% move in either direction between now and December 18th expiration (as of yesterday’s close of $120 in TLT, the Dec18th 120 straddle was $3.45, if you bought that and thus the implied movement, you would need a move above $123.45, or below $116.55 to make money). Even though December options capture the Fed’s expected rate increase, that seems a bit high given the market’s (both stock and bond) apparent comfort level with such a move.

The one year chart below of the TLT shows the fairly well defined 6 month range between $115 on the downside, and $125 on the upside (excluding the August and Sept panics):

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

Consensus seems to be forming on upcoming Fed policy. This could be one of those situations where cheap vol gets even cheaper.  Stay tuned for some trade ideas.