Kevin Walmsley

Foreign Governments Dumping U.S. Assets

How does doing a call-write strategy hedge downside risk? I could see selling the in-the-money calls, especially for February or March, and getting a quick 1.5% with some downside protection. But in the event the bonds yields rise, having out-of-the-money calls short doesn't hedge your position in any way I can see.


On Jan 19 02:22 PM Whippet wrote:

> To avoid the leverage trap on TBT, you can buy at the money (115
> strike) LEAPs puts for Jan 2011 on TLT. For about $23.50, your breakeven
> would be at $91.50 but I would sell them long before then if you
> really think the Treasury bubble will burst within the next 6-12
> months. I'm preferring to go long TBT and sell one-month calls on
> it (a few dollars out of the money) to hedge risk. The leverage
> trap doesn't kill you too bad with this one because its volatility
> is relatively low, and selling calls makes up for this.

Foreign Governments Dumping U.S. Assets

I had a feeling this would be happening, but it's a difficult thesis to prove.

Consider this: spendthrift Middle Eastern governments, along with Russia and China, are accustomed to humming along on a giant sea of exports to America, and using that cash for their own spending, and to support our capital account.
Now, the prices they commanded for crude have collapsed, the Chinese exporters are getting murdered, and the flow of green is drying up. They've now turned to selling dollar-denominated instruments not because of their concerns of US creditworthiness, but because they represent the one asset they do have that can be turned into spendable cash in a big hurry.
Just my take. It would be interesting to see where, specifically, the foreign selling is coming from.

Bubbly Treasuries Will Disappoint

Beware when investors who didn't see the dot-com or the real estate bubbles now pretend they've spotted one in government bonds.

Consider the possibility that we're in a bona fide deflationary environment. In such a case, getting a 0% yield might be a risk-free 4%, given falling real prices across the economy. What's more, foreign investors whose currencies ARE experiencing inflation can still make money in treasuries, buying and selling at par.

Suppose you knew that next year, several hundred billion more dollars were moved out of equities, and into governments, as millions of American 401k and mutual fund buyers merely look at the trailing 12-month returns in their issue of Money magazine. As mutual fund managers, you still have to buy treasuries, irrespective of the price. That can send yields lower still. Japan coasted along for years with an effective negative yield on their paper; who's to say we won't do the same? Just because it seems an irrational trade to buy treasuries here doesn't mean you'll see an exodus into stocks anytime soon.

A lot of sophisticated investors are buying treasuries, with the unsophisticated investors soon to follow. Short govies only at your extreme peril.