Just a few weeks ago, when odds of a June or July rate hike spiked on FOMC minutes that indicated a willingness for a Summer rate hike, we made the argument that it was more likely that we’d see an increase in jawboning and not necessarily rate hikes. Here were some specific thoughts at the time:
I suspect they do not raise in June and merely speak to the potential of a raise at their July meeting, effectively talking rates higher, while trying to avoid a rip in the dollar back to the 52 week highs. Last night on CNBC’s Fast Money I suggested they would find and excuse between now and then to push out a hike.
This morning we probably got that excuse with a terrible miss on today’s NFP report and a downward revision to April.
Following the April Fed minutes it was out inclination to express and immediate term contrarian view via a bullish trade using options in the TLT, the iShares 20 year Treasury bond etf. Here was the rationale from the May 20th post:
Which brings me back to TLT. A sharp move lower is certainly possible, but as stated above, if we get a summer rate hike I suspect it is not followed by a string of hikes. On the flip-side I see a far greater chance of a sharp move higher in the event that rate increases don’t materialize, coupled with the sort of downward volatility spikes we have seen in risk assets on two occasions in the last year, a sort of flight to safety trade could emerge in US Treasuries.
And here was our trade when TLT was $130:
*TLT ($130) Buy the Sept 126 / 133 Risk Reversal for even money
- Sell to open 1 Sept 126 put at $2.50
- Buy to open 1 Sept 133 call for $2.50
Today, the TLT has spiked back near its 2016 highs of which it has seen a couple runs towards $133:
The current position has a 2.00 profit. We want to stay long here but it makes sense to reduce some deltas from our entry and take off our risk while still having exposure for a run to the early 2015 highs closer to 138. So here’s the roll:
- Bought to Close the TLT ($133) Sept 126 puts for 1.30
- Sold to Open the TLT ($133) Sept 138 calls at 1.60
Long the TLT ($133) Sept 133/138 call spread for a .30 credit (currently worth 1.70)
Rationale – What this does is lock in 30c of the 2.00 in current profits and leaves the 1.70 at risk if TLT is below 133 on September expiration. But that Sept 133/138 call spread can be worth up to 5.00, meaning if it is at or above $138 on September expiration we can make up to 5.30 with no risk (except the 1.70 in profits we are risking). The worst case scenario is only making .30. The roll also reduces deltas from about 65 down to 20, but the potential pay-off is still quite similar if TLT is 138 in September. And not being short the 126 put means the margin requirements are greatly reduced.