TLT: Profiting From The Current Situation Strategically

Aug.20.13 | About: iShares 20+ (TLT)

Recently the media has been discussing the up-tick in interest rates and the 20- year treasury decline. TLT is an ETF that represents the 20-year treasury. Unlike buying individual bonds an ETF does carry the risk of loss of capital as interest rates escalate and yields increase. With the backdrop of federal reserve leadership change, an improving economy and alerts to a decrease in treasury bond purchases by the fed "tapering", there are many factors that influence bond pricing. It is generally accepted that rising yields results in lower bond prices. We have been in a raising yield environment that will likely continue through a full recovery of our economy and a return to more normalized Federal Reserve intervention.

Now is the time to challenge the historical recommendation of using bonds to offset a portfolios volatility and correlation with both market increases and decreases. It is also time to evaluate holdings in TLT and decide to hold, exit or increase positions. With all the hype and articles surrounding tapering and yield for treasuries it's critical to accurately and honestly assess why a portfolio might need treasuries, in this scenario represented by TLT. Listening the current media it would seem that buying bonds now would be foolish and bonds should be sold as quickly as possible. But they are looking at price and predictions for yield and interest in the future, not at managing a portfolio.

Why have a position in TLT?

  1. Dividend Yield of nearly 3%
  2. Decrease a portfolios volatility
  3. Increase portfolios diversification

Why decrease a position in TLT?

  1. Declining share price YTD of 7.87%
  2. Interest rate uncertainty
  3. Lock in gains from price appreciation
  4. Opportunity to loser position share basis

Why increase a position in TLT

  1. Dividend yield of 3%
  2. Pricing has plummeted from $120 in January to $102.8
  3. RSI is near an all time low signaling an over sold condition
  4. Momentum has put treasuries out of favor

The strategic value of managing a diversified portfolio is being overcome by the fear of interest rates. The reason to hold TLT is dividends. The number one mistake investors make is forgetting their portfolio objectives and concentrating on "the number". People get uncomfortable when share pricing drives a positions value down.

A look at the chart below which tracks TLT and the TNX it is apparent that price and yield are headed to a convergence target. The Relative Strength Index is close to an all time low. This chart tells me to wait if I'm a buyer and sell if I'm an uncommitted owner. These short term charts demonstrate the anomaly of price appreciation investors in TLT have enjoyed since the 2008 financial meltdown and the unprecedented and untested economic policy of federal stimulus through the printing of money and the purchase of treasury bonds.

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The chart below offers a longer time frame view of TLT performance relative to the TNX. This is the historical data that is most alarming and should force evaluation of a TLT position. You can clearly see that prior to the 2008 crisis interest and TLT moved in a logical price pattern. It wasn't until a zero interest rate policy that interest and TLT diverged and TLT pricing increased dramatically. Evaluating the data challenges the strategy of hold at all costs and earn the dividend.

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Tactical Plan

I generally disagree with responding to timing or short-term threats to a strategic portfolio position but in the case of TLT I foresee significant rational for scaling out of TLT even though I am committed to a diversified portfolio and dividend yield. Action is dependent of share basis. If you have been invested in TLT for a long time and your basis is under $87 then holding, and earning the dividend, is a consistent strategy for ownership. You would be giving back all price appreciation but if your objective is dividend income this would be an acceptable tactic. If the share basis is between $87 and today's price of $102.47 the TLT position should be scaled back. There is significant data suggesting that pricing will decline by more than an earned 3% dividend. Since TLT typically moves in small increments taking profit now is a solid tactic even though owning TLT remains a portfolio objective. Sell TLT and open orders for cash secured puts in the strike $90 to 95 range timed to close by year end. Currently the December 2013 strike 95 Puts are trading at $1.66. This translates to $166 in premium for each 100 shares. This maneuver locks in price appreciation and mimics the dividend with the sell to open put premium. In case shares are assigned the strike is less then the selling price so the net effect is a lowering of the positions basis while banking current appreciation and some premium. This is a case that runs counter to my general thesis of don't worry about the "number" just keep building the dividend stream. There is an opportunity to lower price basis and not loose the effect of dividends that is too compelling to not take advantage of. TLT will continue as a component of the portfolio but at a lower share price as we scale back into shares using sell to open cash secured puts.

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Disclosure: I am long TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.