As everyone is probably aware, long-term US Treasuries have been on a tear this year. Shares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT) is up over 15% YTD.

For some time now I've had a large position in TLT, riding it as a component of two momentum strategies. I last discussed this explained back in *January 2015*, and have held a large position for most of the 18 months since then. While I've enjoyed the gains, I haven't been thrilled with the puny yields from TLT. With this year's 15% run-up, yield is down 14% to 2.24%. I've been kicking that yield up considerably with an option strategy which I'd like to describe.

My approach for earning income with options to TLT has been to sell out of the money covered calls or covered puts four to five weeks out. Should the fund get called, I sell puts until it gets assigned to me. I've targeted options strikes based on the expected probability of the options expiring worthless. I look for strike prices with a probability of expiring worthless in the 67-73% range based on the delta values for the options on the chosen strike data. To make this clear, I select a strike date, 4-5 weeks out. Then I go through the option table to find the strike price whose probability is in that range based on delta values.

Delta is a measure of the relationship between the change in price of the underlying stock and the change in price of the option. For example, at a delta of 0.70, a $1.00 rise in the underlying's price will generate a $0.70 rise in the price of the option. For out of the money calls deltas are positive. For out of the money puts they are negative. I look at absolute values, so the sign does not matter.

So, out of the money option premiums move toward 0 as the strike date approaches. This chart illustrates the phenomenon (from a Google image search but the source link is dead so I'm unable to add a citation).

Thus, at a given time the delta provides an estimate of how the option market sees the price moving. The absolute value for delta is, therefore, an approximation of the current odds of the stock closing in the money at expiration. The relationship between delta and the probability of an option expiring worthless is 1-ABS (delta).

Volatility of TLT is such that the call option for a strike date 4 to 5 weeks with a delta of 0.30 out has been running a fairly consistent premium of about 0.75% of the stock price.

For example, as I write this TLT's last price was $138.92. The 26 August (31 days) $141.50 call has a delta of 0.3169 and a bid of $1.08. If the call expires worthless (69.4% chance as estimated from delta) that $1.08 represents a gain of 0.78% (I'm not allowing for commissions, but my experience has been that one can usually split the bid/ask spread and sell the option at the midpoint, which should at a minimum negate the need to consider the commission cost, at least on the option sale depending on how many contracts in the trade). If the stock is called (31.7% chance) the $1.08 premium is retained plus there is a capital gain of $2.58 for a net gain of $3.66, or 2.63% in 31 days. That's an annualized return of 9.12% if the option expires worthless, and a 31.6% annualized return if the call is assigned.

That risk is that the stock moves greatly beyond the strike price and you forgo those gains from that price rise. In this example the break even point would be $142.58 ($141.50 + $1.08). TLT would have to gain 2.63% at the end of those 31 days to exceed the break-even point.

If the stock is called from you, you can then sell puts. Let's continue looking at today's prices. The 26 August strike price for a delta of -0.3066 is $136 which is $2.92 (2.1%) below the current $138.92 price. The premium bid for that option is $1.07. If the option expires worthless (69.3% chance) you have earned 0.77% in those 31 days for an annualized gain of 9.2%. If you're assigned the stock, well: rinse, lather repeat.

On the covered calls you will be receiving the dividend for an additional 2.2% annualized (except for the periods you are out of the stock due to it's having been called, of course).

As I noted I have been doing this for several months. I had the stock called once and it was put back to me at the end of the next cycle. So far it has been a consistent gainer. Income from premiums is 4.28% for six months. Income from dividends is 0.98% for the same six months. Total gain for the period is 18.37%.

By targeting a lower delta one can sell calls further out of the money for a lower premium, reducing the risk of having the stock called and reducing the option income received. Targeting a delta of 0.20 instead of 0.30 will reduce the probability of having the stock called to near 80%. It will reduce the premium by about half.

One issue that you may have to contend with is the stock falling well below your basis cost as the months tick off. As long as the stock is gaining at a modest rate, everything is fine. A prolonged downturn will mean you could be selling calls at strikes below your basis which will result in a capital loss if assigned.

Many are predicting that TLT is over extended at today's prices and due for a major contraction. That such a contraction may underway may be suggested in the last couple of week's price action. TLT had gone from an 8 July high of $143.05 to today's $138.92. As we saw above if you had to sell calls today the target strike would be $141.50, $1.55 below the basis cost if you acquired the stock at the high. But, TLT typically moves with the inverse of equity, so that recent drop is the expected movement correlated with the upswing for stocks.

I'll only add the many of the same voices warning of dire conditions ahead for Treasury bonds are also broadcasting the same warnings about overvaluation of the equity market. It's a bear thing, I guess.

**Disclosure:** I am/we are long TLT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

**Additional disclosure: **I have no ties to the financial or security industries in any form. My interests are strictly personal. The banker part of the nym has absolutely no relationship to the profession of the same name. Readers should be aware that I am an investing novice. I do not give advice; what I publish is an annotated version of my research notebook for topics that I think will be of interest to readers at a similar level of investing knowledge. Anyone who finds any securities or strategies to be of interest will necessarily want to do his or her complete research and due diligence before acting on that interest. It would be foolish to rely on my conclusions without having done so.