Update – TLT: Bonds, Shaken and Stirred.

by Dan August 5, 2019 9:48 am • Trade Updates

Since early Spring it has been my view that U.S. Treasuries would remain the beneficiary from the ongoing trade war with China:

This from March 6th (Bonds Shaken, Not Yet Stirred):

Its been my view for years as the Fed ended quantitative easing (QE) in 2014 and then ending their zero interest rate policy (ZIRP) in 2015 that their ability to materially reduce their $4.5 trillion balance sheet of assets accumulated since the start of QE in 2008 would massively strain their ability to get Fed Funds back anywhere near “normal” but clearly nowhere near their prior highs above 5% in 2007 and above 6% in 2000. That inability would obviously weigh on the long term trajectory of interest rates, which has been lower… and that we are likely to see zero or negative interest rates far more frequently in the decades to come than we have in the past 100 years.

a story this morning from Bloomberg catching some attention, and causing some to believe that a trade deal with China might not cover the major issues at the heart of our longstanding issues… Trump Pushes China Trade Deal to Boost Markets as 2020 Heats Up… the issue here is that he wants a win so badly that a less substantive deal will only really address the trade deficit and those changes might already be incorporated in market participants expectations and it may not provide the sort of stimulus that the global economy needs after a period of softness, that was caused by trump’s insistence in tariffs in the first place. Oh and not just with our adversaries like China but also the steel and auto tariffs with allies like Canada, Mexico, and Europe. If a trade deal is the last potential positive catalyst to spark a global reflation in growth, then a half baked trade deal is likely to be a big flop and fending off a recession in Europe and Asia seems unlikely, and you know what comes next… the U.S.  To combat that the Fed will get more dovish, rates will go lower while we also see a potential flight to quality in U.S. Treasuries as we normally do in periods of global economic strife.

In that scenario, short-dated options prices in the TLT are some of the cheapest on the board with 30-day at the money implied volatility at just 8%

At the time the TLT, the 20-year U.S. Treasury etf was trading $120 and I laid out a defined risk way to play.

Then in late May when the TLT was just below $129 I updated this trade idea and rolled the bullish view up and out, at the time suggesting (TLT: Bonds… Shaken & Stirred):

Over the next few months, there are clearly a few catalysts for a big rate move one way or the other.. first and foremost a substantive resolution to the trade fight between the U.S. and China would relieve some of the pressures weighing global growth. I don’t think a substantive deal that addresses much other than the trade deficit is in the cards. I suspect the headwinds to global growth remain throughout 2019 and global yields remain suppressed.

Then, of course, there are expectations of the next move by the Fed, which got the party started in January, weeks after their last Fed Funds quarter-point hike, with a pivot to a much more dovish stance. In a matter of weeks, Fed Funds futures were pricing two quarter-point rate INCREASES in 2019 to now what looks like a 50% probability of a quarter-point cut in at their September meeting, and an 80% chance of a quarter-point cut at their December

Well, the Fed cut last week suggesting that trade tensions remain the largest determinant about further rate cuts, and give last week’s tariff increase by trump, Fed Fund futures are now pricing in a 100% chance of a 25 basis point cut at the Fed’s Sept meeting.

In late May the trade idea I detailed was targeting a move back to $140 by Sept expiration, here was the trade idea from May 28th:

-Buy to open 1 Sept 130 call for 2.10

-Sell to open 1 Sept 140 call at 40 cents

Now with the TLT is $138, and the risk-reward to remain long this call spread is now longer great as the etf approaches long term technical resistance:


At this point, it makes sense to take the profit and run with the $10 widespread that is $8.20 in the money with 6 weeks to expiration…

Action: TLT ($138.25) Sell to Close Sept 130 – 140 call spread at $8.60 for a $7 profit