No Mr. Bond Yield, I Expect You To Die – TLT

by Dan September 16, 2019 11:10 am • Trade Ideas

In early August (TLT: Bonds, Shaken and Stirred), for the second time this year, I updated my thoughts and bearish positioning via the options market on long term Treasury yields via the TLT, the iShares 20-Year Treasury ETF:

From Aug 5th when the TLT was $138:

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:

Well TLT shut up to nearly $150 in late August but has since come in hard as the rhetoric on the trade front appears to be a bit more conciliatory than it was in early August, and macro data that might only speak to a 25 basis point rate cut when the Fed meets on Wednesday. The one year chart below shows the parabolic ramp in the TLT in August that started with trump’s threat to increase tariff’s on consumer goods, a day after the Fed said they were monitoring trade tensions as they were a clear determinant in what they called the prior day’s 25 basis point cut, the first by the Fed in ten years as a “mid-cycle adjustment”.


On Friday’s Options Action my co-panelist, chartist extraordinaire Carter Worth of Cornerstone Macro made a bullish case for the TLT, watch here:

The most interesting chart to me though was of the 10-year Treasury yield testing the downtrend that has been in place since last fall after the precipitous drop in August:

It is worth noting that just as the downtrend is not perfect, as Carter has informed me, the best lines, the ones that tend to hold up most frequently are the ones that connect the most dots. While it is not always that easy, it is worth looking where an overshoot could be and that would clearly be a re-test of the psychologically important 2% level.

Mike detailed a trade idea to capture a decline in treasury yields, thus a bounce in the TLT between now and November expiration, targeting a move back towards the mid $144s from $136.50 where it was on Friday’s close. MY comment on the trade was that short-dated options prices have risen substantially in the TLT this year, with 30-day at the money implied volatility doubling since the Spring… options prices were too cheap in May at 7% IV and now at 15%  they are clearly pricing in a good deal of movement, nearly 2% in the TLT a day.

If I were inclined to play for a re-test of the recent highs in TLT I might consider the following trade idea in Dec expiration:

Bullish Trade Idea: TLT ($138) Buy Dec 140 – 150 call spread for $2

-Buy to open 1 Dec 140 call for $2.75

-Sell to open 1 Dec 150 call at 75 cents

Break-even on Dec expiration:

Profits of up to $8 between 142 and 150 with max gain of 8 above 150

Losses of up to 2 between 140 and 142 with max loss of 2 below 140

Rationale: this trade idea risks 1.5% of the etf price, breaks-even up 3% and offers a max payout that is 4x the premium at risk if the ETF is up 8.7% in three months, just above the recent highs. This is a favorable risk-reward for those who have a conviction that rates turn back lower.