For the better part of the last year, I have been bearish on U.S. Treasury yields (rolling call spreads read here), and until very recently that has been the right view. In a post on Sept 16th (read here) I spoke about the most recent drop in yields and what that meant for the TLT, the iShares 20-year Treasury Bond etf:
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”.
Since then the drivers for the sell-off in yields as highlighted above have become more evident, and now the yield on the 10-year U.S. Treasury is at the early August breakdown level and the psychologically important 2% level, a smidge above the downtrend that has been in place since last fall. If yields get through here maybe we get back to the late May breakdown level near 2.20% but that might be it…
To suggest that yields are at a critical technical spot is an understatement, and the slightest bit of bad news on the trade front, or frankly anything else in geopolitics and investors who are a bit giddy on stocks might reach quickly for U.S. Treasuries.
Updating the TLT chart nearly two months from my last post and you see that just this week the TLT dropped back to the $135 support level that is the intersection of the uptrend from the Dec 2018 lows and the breakout level from Aug 31st:
To my eye, this looks to be as good as spot as any to play for a near-term bounce back towards $140, or a move back towards $145 in the new year.
I would also add that a feature of the prior trade ideas in the TLT was also just how cheap options have been in the ETF, the chart below of 30-day at the money implied volatility over the last year shows that options prices have risen when the ETF is rising, as traders are reaching for calls. The point here is that buying calls in TLT means that yields are going lower, and lower yields have meant weaker global growth and/or greater concerns about macro conditions. IV at 12.6% does not exactly scare me off to long premium directional trades in the TLT.
So what’s the trade? Heading into the new year with equities ripping and market participants seemingly convinced that any all headwinds to global growth are in the rearview mirror, I think it makes sense to be contrarian and play for lower yields in Q1 2020.
Bullish Trade Idea: TLT ($135) Buy March 135 – 150 call spread for $3.50
-Buy to open 1 March 135 call for $4
-Sell to open 1 March 150 call at 50 cents
Break-even on March expiration:
Profits of up to 11.50 between 138.50 and 150 with max gain of 11.50 at 150 or higher
Loses of up to 3.50 between 135 and 138.50 with max loss of 3.50 at 135 or lower.
Rationale: again given the current price action in U.S. Treasury Yields and some of the current macro “news” flow, this is clearly a contrarian view, but this trade risks ~2.5% of the ETF price with a break-even up ~2.5% and offers a max potential payout of 8.5% if the TLT us up 11% in a little more than four months.