Positioning for a Bond Rally

By David Russell

One big investor is using options and an exchange-traded fund to bet on a rally in Treasury bonds.

The Shares Barclays 20+ Year Treasury Bond (TLT) fund lit up our Heat Seeker tracking program today as new money streamed into the November 95 calls. Most of the large trades in the ETF priced for $0.35 to $0.40, and volume in the strike was more than twice open interest at 14,418 contracts.

The TLT, which tracks government bonds maturing in 20 years or more, is up 0.09 percent to $93.32 in afternoon trading. The fund traded as high as $100 at the beginning of last month. The call buyer needs the ETF to rally roughly 2.2 percent by expiration to turn a profit.

The trade was executed after the yield on the benchmark 30-year Treasury bond rose to 4.46 percent, the highest level since mid-August. The call buyer apparently thinks that yields will reverse lower, which would push up the price of the TLT.

The sentiment is generally bearish for the broader market because lower Treasury yields tend to correspond with lower stock prices.

Overall options volume in TLT was about 40 percent greater than average today. Calls outnumbered puts by 6 to 1.

(Chart courtesy of tradeMONSTER)

Comments

[Jasper M:]

I used to be expecting that, as well, on flight to quality when the rally ends. But the technical indicators look sketchy, and with the fundamental picture looking SO bad, I can't help but expect that the quality flown to will end up being something besides T-bonds. Or even the longer T-notes.

In my minds eye, I see a picture of Obama, Bernanke, and Geithner, over the caption "Would you buy a used bond from these men?"

Nov 07 01:38 AM

[David White:]

The UUP also made a huge move up yesterday on mostly increased premium as the USD Index barely moved yesterday or today. Some of the premium disappeared today, but a lot is still there. UUP requested registration for 100M more shares.

The people buying the long bonds are probably not planning on holding the bonds too long. If we get a rise in the USD, which many are predicting short term (especially Prechter). It would push commodities and equities downward. People would want to get out of the USD carry trade on a USD rally. They would have to sell other assets in order to repay the USD's. This would push commodities and equities (many of which are commodity based) downward. When equities and commodities fall there is usually a flight to quality (bonds). This drives the price of the bonds upward. If the investor then sells those bonds at the near term bottom of the market, the investor earns extra money from the appreciation of the bonds. This is a plan that could work. Of course, the timing would have to be good. Plus you have to sell near the bottom. You also want to sell before the Fed starts pressuring the market with interest raises. Bonds would go down with a rate increase by the Fed (or perhaps even with the expectation of one in the near term).

The USD going up is not definitely necessary for this scenario. One could just figure the markets are tiring. Plus oil was at about $80. Both looked like they were poised to make a move downward. With the higher than expected unemployment it would seem likely that oil prices would move down on the expectation of a cooler economy. With higher unemployment people will spend less on gasoline, etc. Decreased demand should lead to a decrease in the price. Ditto for many other commodities. Equities would follow. Equities markets are already showing signs of being tired. They are ripe for a retracement.

Nov 07 03:43 AM

[TraderRob:]

There's going to be a Mexican Standoff between the industrial commodities, precious metals, Treasuries, U.S. equities and the Dollar. It would make perfect sense for the Dollar to pop higher as equities fall with industrial commodities, there by forcing money into the relative safety of Treasuries and Gold.

However, there will be a time where the safety of U.S. debt at historically low yields no longer makes since and Gold becomes the only refuge.

Watch for the diversion of Gold and long term Treasuries to be marked by a truly dismal confidence shift in equity markets.

Nov 07 07:06 AM

[logicalthought:]

I'm not a "bond guy" but it seems to me that there's something wrong in "bond land", and I smell a huge yield spike right around the corner. Of course we all know the reasons why this "could" happen (the deficit, the money-printing leading to a declining dollar, etc.), but the reason why I think the timing is very close to "now" is the strange action in the bonds this past week. When the Fed announced on Wednesday that it would keep rates unusually low "for an extended period of time", the yield on the 10-year spiked massively HIGHER. What does that tell you?

Nov 07 07:57 AM

[Northern Da...:]

Something's fishy about this. Since 90% of the profits made in options trading goes onto the ledger of options sellers, a seller had better know what he's doing. By "know", I mean "know because they control" what the future holds. The only players who would invest that kind of money in one solid block of that many calls would be the seller. And who is big enough to invest that amount of money and yet "know with certainty" what the future holds? My hunch would be GS.

The first sentence that the author wrote in this piece is: "One big investor is using options and an exchange-traded fund to bet on a rally in Treasury bonds." He didn't say that the "one big investor" was the "buyer" of the calls. In fact, I'd bet my left one that the biggest player was the seller of those calls.

Mr. logicalthought, who's post is just above mine is guilty of logical thinking. That's all I understand, and he sure makes sense with his observation. He's seeing something fishy from a different perspective (very astute I might add) than I am, but it appears that our conclusions are pointing in the same direction. Like I said, something sure seems fishy to me... as in fish "tank".

Nov 07 11:24 AM

[djj420:]

When TLT/long bond buyers jump off the sinking ship/toss the hot potato, TBT will go thru the roof. To really believe that long-dated US treasuries are a good long term investment at anywhere near current rates is the purist of folly. Even at higher rates, long-dated US treasuries would not be a smart investment, as the rise in rates will be reflective of both inflation in the pipeline and tangible risk of eventual default.

Nov 07 12:27 PM

[TxTim:]

Good Comment. The Fed also said in the same statement that it would extend QE by another $ 1.625 Trillion. IMO that would move bond market rates higher, as well.


On Nov 07 07:57 AM logicalthought wrote:

> I'm not a "bond guy" but it seems to me that there's something wrong
> in "bond land", and I smell a huge yield spike right around the corner.
> Of course we all know the reasons why this "could" happen (the deficit,
> the money-printing leading to a declining dollar, etc.), but the
> reason why I think the timing is very close to "now" is the strange
> action in the bonds this past week. When the Fed announced on Wednesday
> that it would keep rates unusually low "for an extended period of
> time", the yield on the 10-year spiked massively HIGHER. What does
> that tell you?

Nov 07 03:52 PM

[E Nuff Sed:]

Looks like the entire US deficit + stimulus is being funded is going to funded by the Fed (via QE) till 2012.
There are only 2 ways to get out of it - (a) devaluation of the US dollar or (b) higher taxation.
I am betting the politicians will choose (a) to pander to the public.

Nov 07 08:35 PM

[PastTense:]

E Nuff Sed::

Obviously another alternative is cutting spending.

But I agree with you about the politicians will do--devaluation.

Nov 08 01:29 AM

[Peter Cooper:]

Nobody ever lost money in the long term by betting against central banks propping up their currencies. They always fail so this is a sure fire trend situation, see: arabianmoney.net/2009/.../

Also, what happens to stock prices when the Fed can not cut rates as it usually does in a crash? The crash will be deeper. But then if rates are not cut then bonds will not rally - or at least not by the same amount as if rates were cut. Could this lead to a bond crisis?

Nov 08 05:46 AM

[Kinetics63:]

I don't know if you could call me a 'Bond guy', but I do only scalp interest rate futures and I have to tell you: at least the belly and short end of the curve seem to want to go higher. There is a lot of fear out there and the Japanese among others are buying treasuries like there is no tomorrow. They seem to think treasuries are a bargain. Do I agree? Hell no, but who am I to argue with those who move the markets.

I get scared shittless when I go long treasuries and yet I just went long the 5 year note tonight on a pullback because the price action tells me to do so. At the moment my stop is just below Fridays low and I will wait for regular trading hours in the morning to add to it on a further pullback close to that point.

I could be wrong but I have to make the bet.


On Nov 07 07:57 AM logicalthought wrote:

> I'm not a "bond guy" but it seems to me that there's something wrong
> in "bond land", and I smell a huge yield spike right around the corner.
> Of course we all know the reasons why this "could" happen (the deficit,
> the money-printing leading to a declining dollar, etc.), but the
> reason why I think the timing is very close to "now" is the strange
> action in the bonds this past week. When the Fed announced on Wednesday
> that it would keep rates unusually low "for an extended period of
> time", the yield on the 10-year spiked massively HIGHER. What does
> that tell you?

Nov 09 03:41 AM

[Kinetics63:]

Ok. Now I just reversed my positon and went short the 5 year note. That was one of my few swing trades. Time to ride this down a bit if it doesn't break todays high and then start scalping again.

Nov 19 03:49 PM