This Bond Trading Strategy Sets Up After Today's 30 Year Treasury Auction

Includes: TLT
by: Nat Stewart

One of the patterns that I study, track, and trade is the price action that occurs before and after the monthly 30 year Treasury bond auctions in bond futures and in the iShares Barclays 20+ Yr Treasury Bond ETF (NYSEARCA:TLT).

This auction has been taking place on or around the second Thursday of each month, usually between the 8th and 14th. This month's 30 year auction occurs today, June 13th, 2013 at 1pm EST. The basic idea for the trade is that price tends to dip in anticipation of new supply, and then rallies after the new supply has been absorbed by the market. In other words, a short-term price discount is created in order to stimulate demand and help the market absorb the new Treasury issue. Please note, While I am using futures data for this study, the strategy works very well when in the iShares Barclays 20+ Yr Treasury Bond ETF. Let's run some numbers:

You can read the above table as follows: The second column is the benchmark. It is the non-overlapping two day holding period return ($72) for the 30 year futures contract over our evaluation period. The third column (2 days before) is the return from buying on the close three days prior to the auction, and selling on the close the day before the auction ($-62.50). The fourth column reflects buying on the close of the auction day, and selling on the close two days later ($421).

As you can see, the results match the "trader narrative" that exists about auction price behavior. Note, the two day holding period was chosen for example's sake. It is not an optimized value. In my own trading, I have found that there are additional criteria that substantially add to the expected value of the trading idea. It is a conjunction of factors that can take the trade from "interesting" to "exceptional".

I know that for many readers, the above table is not tangible enough to be meaningful. For this reason, I like to graph how a strategy can work if gains are compounded over time using a simple money management formula. The following graph is a simulation of using the "two days after" strategy in conjunction with a "trade one futures contract per $20,000" money management rule:

There is more to effective trading than quantitative analysis and studies such as what is presented in this article. Here is an article that details some of the areas where traders tend to go wrong, along with solutions. This kind of material is important, because it bridges the gap between understanding an opportunity, and actually profiting from it.

In the real world, this type of strategy would not typically be traded as a stand-alone approach. Traders build portfolios of these trading strategies so that each trading edge is just one player on a larger team. The smart ones also keep their studies updated and continually look for improvements and new ideas.

PS. The "vanilla" approach to this idea took one of its worst hits in recent memory last month. Lets see if it bounces back this time!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I trade Treasury Bond Futures (ZB) on a daily basis.

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