[Options] Settle Down, Interest Rates!

Sean McLaughlin
March 24, 2021

We've seen quite a move lower in $TLT (which moves inversely to interest rates) since this summer.

Is the bottom in?

My crystal balls says: "Don't ask me stupid questions." So, that's no help.

But here's what I know:

  • Implied volatility priced into $TLT options is relatively high, though declining from recent high levels.
  • We have a clearly defined level (of perhaps temporary) support at $133.
  • High volatility gives us the ability to short options and gives us plenty of room to be wrong and still make money.

The bet I'm making is $TLT is going to chop around in a bit of a range over the next 2-6 weeks and this will cause volatility to contract.

So here's how I'm going to play it:

I'm selling a $TLT May 131/144 strangle for a net credit of $2.25. This means I'll be naked short both the 131 puts and 144 calls for a net credit. This credit represents the most I can possibly win in this trade (if both options expire out-of-the-money).

Due to the theoretically unlimited risk which is a feature (not a bug) of naked short options, I'll size my position small.

My goal is to close this entire spread down for a profit when I've captured 50% of the maximum possible gain. So in this case, if I sold the spread for $2.25 at trade initiation, I'll look to buy it back at around $1.10.

Risk management here is of extreme importance. If $TLT closes below $133 per share at any time during this hold, then the bottom is still not in and I don't want to be holding naked short puts into the abyss. So I'll close the trade down in that event -- taking my manageable loss and moving on.

On the upside, if $TLT closes above our short call strike at $144 per share, that will also be my signal that I want to exit the trade -- win or lose.

Subscribers with any questions on this trade can  send them here.

~ @chicagosean

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