Profiting from Bond Droppings (TLT)

A number of ‘big names’ from the investment world sounded off last week about the bond market and the toll that rising rates would eventually take on equities.

None other than Warren Buffett, zillionaire, stated outright that the long bond was a short sale. Bill Gross, once manager of the world’s largest bond fund at PIMCO and now at Janus, predicted that not only was the thirty-five year bull run in bonds coming to an end, but stocks, too, had seen their day.

We’ve also been speaking of a bond bear for the better part of the last eighteen months and have been confounded (along with many others) as the long end of the curve refused to turn over. Calling an absolute top for Treasuries has not been a simple affair.

But could it be the most recent, steep selling frenzy in the bond pits will prove the ‘giants’ correct? Because not only here at home, but in nearly every major industrialized nation the backup in both ten-year and long bonds has been formidable.

Take a look here –

10-YEAR-YIELDS

We’ve highlighted the biggest moves with a red circle. The actual ten year rate is recorded in black. And as you can see, across the board there have been huge drops in price (yields and prices move inversely). In just the last two weeks, EURO, UK and Aussie yields have popped by roughly 40 basis points (bps), and that’s significant. It’s also likely what caught the eye of Messrs. Buffet and Gross, among others.

Take a closer look now at the iShares 20+ Year Treasury Bond ETF (NYSE:TLT), a good proxy for the long end of the curve. And note in particular how quickly its price has fallen from all-time highs in late January.

NYSE-TLT-DROP

Here’s a textbook picture of weakness, at least for the short term.

After breaking through all her moving average support lines, save the long term 411 DMA in yellow (at blue arrow), TLT is now a shoo-in to drop to $116 over the next few weeks.

It’s likely we’ll see a bounce at that stage of some duration, but if price slices below $116 on continuing strong volume (in black), we could see much lower values a month or two from now.

All will depend upon the RSI indicator (in green), a technical gauge watched by nearly everyone in the industry. If the fall to the 411 day moving average coincides with an oversold (sub-20) read on the RSI, we’ll bounce. If we slice below that line before triggering an oversold indication, then it’s more than likely Warren and Bill’s timing is impeccable.

BONDS-OVERVALUED

More on the long bond in a moment. But first, let’s address two open trades.

The first is a number we opened exactly two weeks ago that has panned out wonderfully.

The letter was called A Great Wall of Market Madness, and therein we argued that the Chinese Market had hit a glass ceiling, so to speak, at least for the time being. Authorities in Beijing were not pleased with the incredible spike in stock prices of the previous month and would seek to rein in the wild speculative rush that fueled it.

We also said that stemming that tide would force cash flows back toward U.S. markets, zapping our domestic indexes higher for the next six to eight weeks, at least.

And what happened?

Well, the original trade went like this –

We urged you to purchase the FXI July 50 PUTs for $1.90 and sell the DIA July 170 PUTs for $1.87, for a total debit of $0.03 per pair traded.

And today?

The FXIs are fetching $2.48 and the DIA’s go for just $1.50. Sell the former and buy back the latter for a take of $0.98, or an otherworldly 3167% in just a fortnight. That’s 82,333% annualized.

Do those numbers excite you?

Or would you prefer Wanda?

SHARP-STICK

We hope you piled on with this one and made off like The Grinch.

One more trade to address.

It was initiated on February 10th in a letter called Trading Truth for Pravda, and now it’s underwater.

Recap:

At the time, oil was trending lower and the Russian market was taking a mean hit. We bet that she wouldn’t recover in the upcoming quarter, and we were wrong.

The trade we put on went as follows –

We recommended you sell three RSX (Market Vectors Russia ETF) May 18 CALLs for $0.85 each, for a total credit of $2.65.

And today?

RSX trades for $20.32, putting us down $6.96 on the trade, less the $2.65 credit we pocketed at the beginning. That’s a net loss of $4.31 if we leave it as is.

But we have no intention of doing that.

Because expiry is just three days away, and it looks like Russian stocks are stalled for the time being (see chart below), we’re going to sell some PUTs on RSX to mitigate the loss.

To understand our thinking, have a look at a daily chart –

RSX-MOVING-AVERAGE

In brief, Russian stocks are being squeezed between two, rising moving averages from below (in blue), and two falling moving averages from above. The lower offer support – the upper, resistance. Diminishing volume (in black) and negative divergence (red) speak to immediate weakness, a situation that’s prompting us to let our former trade stand until Friday’s expiry, even though it’s currently in a losing position. We’re betting the loss will be further mitigated in the days ahead.

On the other side of the coin, RSX has likely bottomed and should see higher values in the months ahead. Here’s our first trade –

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We feel safe selling PUTs below support at $18.

Options Trader Elite recommends you consider selling eight (8) RSX August 18 PUTs for $0.60 each for a total credit of $4.80.

[/mepr-rule]

[mepr-rule id=”988″ ifallowed=”show” description=”executive_lounge_members_only]

We feel safe selling PUTs below support at $18.

Options Trader Elite recommends you consider selling eight (8) RSX August 18 PUTs for $0.60 each for a total credit of $4.80.

[/mepr-rule]

What about the long bond? Aren’t we trading that today?

You bet, sport.

While the daily chart of TLT we showed you above is certainly bearish, the weekly further makes the case.

Have a gander –

TLT-BONDS-WEEKLY-CHART

Clearly, after the overbought RSI print in January, the die was cast (red circle). TLT retreated in earnest, RSI plunged below its waterline (in black) and MACD is scheduled to confirm with its own dive over the next ten to twelve trading sessions.

The Fibonacci retracement level for the whole move that began in December 2013 (in blue) brings the stock to $115. And it’s precisely there we recommend you open a speculative PUT position. Here are the specifics for this second trade –

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Options Trader Elite recommends you consider 1) closing your FXI/DIA spread, as detailed above, 2) selling 8 RSX PUTs as detailed above, and 3) purchasing a speculative TLT August 115 PUT, now trading for $2.44.

[/mepr-rule]

[mepr-rule id=”988″ ifallowed=”show” description=”executive_lounge_members_only]

Options Trader Elite recommends you consider 1) closing your FXI/DIA spread, as detailed above, 2) selling 8 RSX PUTs as detailed above, and 3) purchasing a speculative TLT August 115 PUT, now trading for $2.44.

[/mepr-rule]

With love of the hunt,

Hugh L. O’Haynew

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