Friday, July 1, 2011

Bond Drop Means Rally in TBT Inverse ETF Upside down ETF gets bullish as bonds fall

The recent surge in equities has brought a sharp drop in bonds. Savvy traders can use that to find an opportunity in the options market.

Of the bevy of bond exchange-traded funds I usually stick with the most liquid of the bunch — theiShares Barclays 20+ Year Treasury (NYSE: TLT) and the ProShares UltraShort 20+ Year Treasury (NYSE: TBT).

Over the past three days the TLT has declined 3.5%. While a fall of this magnitude may not seem like much by stock standards it’s actually a decent sized move in bond land. Since the TBT is a leveraged inverse ETF it has simultaneously staged a notable advance bringing it back above its 50-day moving average (see chart below). If TBT is able to hold above this key level and continue the reversal into an intermediate uptrend, traders may consider entering short put plays. This generates premium income if TBT continues steady or higher and the options expire worthless.

Selling puts seems to be a good fit for the TBT for the following reasons:

1. Given the cheaper price tag of this ETF the margin requirement for short puts is quite low.

2. TBT offers strike prices in $1 increments offering traders numerous strike prices to choose from.

3. Options on TBT are super liquid with most out-of-the-money puts boasting bid/ask spreads a few pennies wide.

July options have insufficient extrinsic value to make short puts worthwhile so I’d suggest sticking with the August cycle. I’ll be stalking the TBT Aug 33 or 32 Puts in the coming weeks.

Source: MachTrader

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