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Brent Leonard
Send Message Retired options and stockbroker, ROP, RIA Retired Adjunct Professor of Finance at Golden Gate Univ. Editor, TSAASF Review Private Investor Author: Zero (IN)Tolerance, blogs: More
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Zero (IN)Tolerance
  • The Trade Of The Year 2 comments
    Sep 12, 2011 1:36 PM

                As one of the more reliable investment sources that I know, would you take a minute to critique what I consider the optimal investment strategy in the current environment, on a Risk/Reward basis?: Covered Calls on a 20-year Treasury.


    Buy the TLT, (the twenty year Treasury ETF) right now priced at @$114 a share.

    Sell an in-the-money covered call at the 106 strike price, which is at a Support level, and provides an $8 Safety Net. Currently priced at $9.50, this call option is composed of $8 intrinsic (in-the-money )- think of it as a "rebate"; the other $1.50 is call premium, which you keep.

                The TLT 20-year Treasury, which the Fed has indicated it will buy to reduce long term yields (the Twist) also yields @3.5%, paid MONTHLY. Combining the 3 payments of @$.33 before December expiry (of $1.00) with the $1.50, you receive 2.25% in three months, or 9% annualized if done 4 times. The short duration allows you to adjust the strike price. Not a "home run", but much better than MMFs or CDs.

                With rates frozen until 2013, the risk of the TLT falling below 106 is the same as seeing a blond male cable TV personality? Even so, you can hedge it with the TBT inverse ETF, which, as I show in my book -Zero (NYSE:IN)Tolerance - has a high inverse correlation to the TLT.  

                So, in your opinion, what could possibly go wrong with this picture, especially compared to the risk in other asset classes at this time? With the disclosure that I have a large position in this plan, thank you for your time and consideration.

    Disclosure: I am long TLT.
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  • Raj2020
    , contributor
    Comments (154) | Send Message
    Leonard - If you expect TLT to stay above its current price in the next 3 months, this approach will definitely have the stock called away. However, downside risk is not mitigated should the price drop (It was at $ 95 just a couple of months ago). Why wouldn't you just buy a Jan 2012 $105/$112 call spread for a net debit of $ 5.35? If stock stays above $ 112 this will result in a net profit of $ 165 per contract (a 31% return in 2 + months) with limited risk ( $ 5.35).
    8 Nov 2011, 11:08 PM Reply Like
  • Brent Leonard
    , contributor
    Comments (73) | Send Message
    Author’s reply » Raj - yours is a legitimate alternative strategy, but with more risk. In these volatile times I prefer a defensive, conservative one - a hybrid that converts the stock market from appreciation (hope and fear) into a fixed income one. After 25 years of "buying" options, I now prefer to sell them, on high dividend stocks/ETFs. If the TLT Dec call expires at 106, I can then step down to the 95, with a higher dividend yield and the concomitant safety net.
    9 Nov 2011, 10:09 AM Reply Like
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