Follow Up – (TLT) December 10, 2012

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price.

Trade Alert – (TLT)

Buy the iShares Barclays 20+ Year Treasury Bond Fund (TLT) December, 2012 $117-$122 call spread at $4.75 or best

Opening Trade


expiration date: December 21, 2012

Portfolio weighting: 10% = 21 contracts

I am going to “strangle” my existing (TLT) position. No, I am not going to put my hands around its neck and choke the life out of it. Instead, I will buy the iShares Barclays 20+ Year Treasury Bond Fund (TLT) December, 2012 $117-$122 call spread at $4.75 or best.

This is a bet that the iShares Barclays 20+ Year Treasury Bond Fund (TLT) trades at or above $122 on the December 21 expiration in 9 trading days.

Adding this together with my existing $127-$132 bear put spread, what you get is a position called a short “strangle.” The combination of the two is a bet that the (TLT) doesn’t go below $122 or above $127 by the December 21 expiration in nine days. It also gives me a small increase in my “RISK OFF” presence in what is a heavily “RISK ON” weighted trading book.

This is a pretty professional trade, so you might not want, or be able, to do it. Some will be constrained for margin reasons, others because their commissions structure is too high. A profit of only 25%, or only 5.3% in nine trading days is not what great fortunes are built upon.

But is does bring in some incremental income in what has been a pretty tough year for most traders. This is why hedge funds often have this position on, especially going into the traditionally dead Christmas season. Their need to make money knows no bounds. If you are unable to execute for whatever reason, then watch and learn. That is what the Trade Alert Service service is all about.

I am convinced that the risk markets put in a six-month bottom on November 16. The only question from here is whether we chop sideways for the rest of the year, or keep drifting up.

To complete this lesson, simultaneously selling short call and put option strikes that are far about, like I did with the $122 and the $127 in the (TLT) above, is called a “strangle.” Simultaneously selling short identical call and put option strikes, like the (TLT) $125 calls and puts, is known as a “straddle”. However, short straddles require far more attention and risk control than the average individual investor is able to deliver, so I went with the strangle.

The way this ends is that the fiscal cliff is resolved shortly after the expiration of this position. That will produce an explosive move up in risk markets, and a dramatic selloff in the Treasury bond market. One thing I know for sure is that attempting to trade the dueling headlines emanating from Washington is a hopeless enterprise that can only end in tears.

The best way to play a market like this is with a position that has an embedded short volatility element to it. The short (TLT) $117-$122 — $127-$132 strangle is the perfect way to do this. That way, if nothing happens, you still get paid, in this case, 0.53%. Nothing is better than that.

The Treasury bond market has been absolutely dead in the water since July. Watching the trading action has been like watching paint dry. Not even the surprise announcement of QE3 could get it off the bench.

That is because the Federal Reserve’s latest monetary easing is entirely focused on mortgage-backed securities, such as those bonds issued by Fannie Mae and Freddie Mac, bypassing the Treasury market. For this trade to work, we only need this somnolent state of affairs to continue for another week.

You shouldn’t have to do anything on expiration day. The following Monday, the net profit will be credited to you account as cash, and the margin freed up. Most online brokers automatically offset your long put position with the expiring short put. It’s that simple. Such is the magic of in-the-money option spreads. But check you online account today just to make sure this was done, and call them and raise hell if it hasn’t.

The best execution can be had by placing your bid for the entire spread in the middle market and waiting for the market to come to you. This alert is for the monthly options. Don’t buy the weeklies by accident. The difference between the bid and the offer on these spread trades can be enormous. Don’t buy the legs individually or you will end up losing much of your profit up front. If you don’t get filled, then just wait for the next Trade Alert. There will be many fish in the sea.

The same applies if you don’t understand this trade. Better to watch this strategy unfold on paper in the model portfolio before you try it with real money.

Keep in mind that these are ballpark prices only. Spread pricing can be very volatile on expiration months farther out. These are the trades you should execute:

Buy 21 December, 2012 (TLT) $117 calls at…………$7.95
Sell short 21 December, 2012 (TLT) $122 calls at….$3.20
Net Cost:……………………………….…….……….$4.75

Maximum potential profit at expiration:
$5.00 – $4.75 = $0.25

(21 X 100 X $0.25) = $525, or 0.53% profit for the notional $100,000 portfolio for a three month position.

Wake Me Up in 9 Days!

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