How To Take Advantage Of The Impending U.S. Bond Crash

Includes: TBT, TMV
by: Individual Trader


Bonds have been rallying for 33 years and are now in a huge bubble.

Imminent interest rate rises will put a lot of pressure on bond prices.

TBT and TMV are good plays right now.

I think that there isn't much upside in US bonds unless it's in the short term. The major concern is definitely the budget deficits that the US has at the moment. When a country has extremely high budget deficits, it usually pumps money into the economy through bond purchases, etc. Unfortunately this course of action usually leads to higher fiscal deficits in the future which puts a lot of pressure on bond holders as they are the ones holding this debt. As a result of this incessant bond purchasing, the fiscal debt continues to rise until the interest payments on its debt becomes unbearable.

At this inflection point, the government needs to decide whether to partially return the money (default) it owes to its bondholders or continue its bond purchases but will have to do so on a much larger scale due to the increasing fiscal debt (inflation). Either scenario here is negative for bond holders and once astute investors notice this new risk in the market, capital starts to leak out, usually quite quickly.

Here is a chart of US bond yields over the last 140 years. It is evident from the chart that we are nearing a top in bonds prices (bottom in yields) and this market could roll over any month now..

Click to enlarge

So how can an investor play this impending down move or crash in bonds? Well we can play this using a number of instruments. There is the UltraShort 20+ Year Treasury (NYSE:TBT) which is a leveraged ETF that moves 200% inversely to the standard underlying 20+ bond price.

Also Direxion Daily 20 Year Plus Treasury (NYSE:TMV) which moves 300% inversely to the standard underlying 20+ bond price. These instruments should be real winners in the forthcoming years but as with all leveraged ETFs, you must have fantastic risk management skills as these instruments can wipe out your account in no time if you are over leveraged.

However, there is another way you can play this trade. If you want to buy 100 shares now of TMV, it would cost you in the region of $5,000. To control the same amount of shares you could buy a deep in the money (Leap) call option for far cheaper. For example you could buy the (40 Jan'16 Call) for roughly $1,300.

The delta on this call option is 78% meaning the call option will move roughly 22% less than the underlying TMV. The option will expire worthless in January 2016 giving you nearly 2 years for your trade to work. Your total risk is what you have invested and if the trade still hasn't moved in your direction by expiration, you could always roll your trade out another few years to give your trade more time to work.

Disclosure: The author is long TMV. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.