Why TLT Options Are Saying Sell This Rally

Jan.11.12 | About: iShares 20+ (TLT)

As anyone who reads my articles knows I'm pretty skeptical (bearish) of the markets in general. I believe the market as a whole being a "zero sum game" where one person wins and one person loses has set up an insanely hard market to play as large hedge funds and extremely wealthy investors rule the market. They have tens of thousands of people researching information and specialized computer systems making decisions in milliseconds which the average retail investor has little to no chance of beating.

However, every once in awhile there is a divergence which develops which could allow the average retail investor to actually make some money (or avoid losing it). Today I am writing this article pointing out what I believe is developing into such a divergence.

In the beginning of 2011 it was a widely popular thing to short treasuries believing the 10-year at 3% was a steal for shorts. Initially it appeared to be correct until Greece and Europe woes began to put pressure on the yields in mid March. The relationship between stocks and bonds has always been interesting as one is always a leading indicator of the other in one form or another.

This is why I bring your attention to the relationship between Barclays 20 Year ETF (NYSEARCA:TLT) and the SPDR S&P 500 ETF (NYSEARCA:SPY). Both are great trading tools for people looking to get in and out of markets quickly, and using options due to reduced IV can be a great way to hedge any bet. However, I want to point out the recent price action in TLT, and even the bull favorite Lehman UltraShort 20 (NYSEARCA:TBT), both of which have been showing a completely different side to this rally.

Click to enlarge

Click to enlarge

Chart provided by Trademonster Inc.

Historically bonds have always been a great indicator of market direction. However, in the first six trading days of 2012 a much different story has developed. The TLT as shown above in the past trades almost lockstep inverse to the overall market. This is a great correlation as it shows money rotating out of bonds and treasuries and into equities. 2012 trading thus far has been anything but correlated. Even on up 1% or more days the TLT has not sold off as one would expect. This is no more than confirmed in the TBT as every time it begins to rally it is pushed back down by decent volume selling.

In the case of TLT the options blocks have remained bullish (bearish for stocks). Positive net option deltas and net premium have been overwhelmingly bullish where if you just look at put call ratios you would think otherwise. Thus, if you look at the deltas and premium the puts are being sold and calls are flat. Take Tuesday's biggest trade in TLT, for example. A 1:3 put February put ratio went off where the 117s traded 10K times and the 109s traded 30K times. The trades went off in the middle of the bid ask spread and therefore the backspread was not clearly bought or sold.

I believe the 117s were sold and the 109s were bought. If this is the case then the trader effectively collected 1.2M on the trade and is playing theta or time decay. This is a very interesting as one side of this trade would profit on a market selloff or a rally with heavy rotation out of treasuries.

In conclusion I'm very nervous regarding this market as yesterday I closed more than 60% of my shorts and went net long the market. I actually joked with a trader this is the ultimate sign of a market short-term top. This was purely technical driven as my stops were basically at the 1,285 level on the S&P. I still believe there is more pain to be felt out of the eurozone which will hurt our equity market in the short term. 2012 has proved me wrong thus far but it is nice to know at least TBT and TLT agree with my thesis as someone has to win. Either TLT is hugely overbought and TBT is big time oversold at this level or the market is overbought and ignoring the treasury market and I do not believe it will stay decoupled forever. Regardless traders will be in for some very interesting trading in 2012.

Disclosure:

I am long AGNC, SDS, APC, WBMD.

I am short: SIAL, JNY, RAX, LNKD, FINL, AMZN, TMO, SWY, MU, INTC, AA.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment professional as to the suitability of such investments for his or her specific situation.