Interest Rates at a Fork in the Road

Sean McLaughlin
July 3, 2019

In last night's All Star Options Conference call, JC laid out a case for why interest rates look to be at an inflection point -- the takeaway being that a big move is likely to happen from here. The problem is, we're just as likely to rise as we are to fall. What to do?

While this type of directional indecision is likely to give pause to a straight equities player, we options traders can position ourselves to profit in either direction without having to pick one!

Here is the chart of $TLT we shared which clearly shows our current levels and the potential move possible in either direction:

The way to take advantage of a thesis that a big directional move is fixing to set up in either direction is to be a buyer of a strangle (out-of-the-money options) or a straddle (at-the-money options). But you only want to do this when the volatility being priced into the options isn't too expensive -- like it is today.

Here is the risk profile chart of a long October straddle in $TLT that we shared last night:

As I type these words during pre-market trading hours, the market in shares of $TLT is gapping a little higher this morning so we're moving our strikes up from 133 to 134, but the trade is essentially the same.

Here's the Play:

We're buying the October 134 straddle for an approximately $5.65 debit. We'll pay up a little if we half to, but definitely not more than $6.00. This means we'll be long both October 134 calls and an equal amount of October 134 puts. Our risk is defined to the debit we paid, but the nice thing is, we'd only incur that maximum loss if $TLT pinned a close at October expiration at precisely 134 -- our strike price. This is a highly unlikely scenario, and even if it were to happen, we'll be long gone before that happens. Here's why: Once the calendar turns to October, if $TLT is trading anywhere between our two breakeven levels (calculated by adding the debit paid to our strike price and also subtracting the debit paid from our strike price) we'll close the losing trade down before theta drag accelerates as we approach expiration.

Meanwhile, if at any time while holding this position the value of the full position doubles, we'll sell half and try to ride the rest for profits -- comfortable knowing that our original risk capital is off the table.

At any point during the life of this trade, if you have any questions, send them here and I'll be happy to discuss with you.

~ @chicagosean

 

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