[Options] Something is Brewing in Bonds
[September 7: stop on this trade has been updated to 96 as we approach expiration]
"Gimme something messy."
This was the directive today when looking for a chart in a stock or sector ETF that was exhibiting consolidating trading action and low implied volatility ("cheap") options.
A few names were batted around and we landed at this chart of the 20-year T-Bond ETF $TLT:
After putting in a low in October of last year, $TLT has spent 2023 frustrating bulls and bears alike in a trading range bounded by 99 and 109.
Meanwhile, notice how options premiums, as expressed by this implied volatility chart for $TLT, have been trending lower since $TLT bottomed last October and are near the lowest levels?
This trend can surely continue lower, but this isn't the bet we're making. We're betting that $TLT is set for a range expansion soon and we want to leverage cheap options premiums to position for a big move in either direction for $TLT.
Here's the Play:
I like buying a $TLT September 103 Straddle for approximately $6.25. This means we'll be long both the 103 calls and an equal amount of 103 puts. And this debit we pay is the absolute most we can lose if we held this position all the way until expiration (we won't) and $TLT closed precisely at $103 on September 15th (unlikely).
While it is unlikely we'll suffer a 100% loss on our invested capital, I will look to manage risk if the position losses 50% of its value. At that point, I'll cut the dead wood and move on with my life.
What we're hoping for is a range expansion that takes $TLT either north of $109 or south of $99. If that happens, then we'll likely be holding a profitable position. That said, I'm not going to be greedy with this trade...
If our position doubles in value to $12.50, I'll exit the trade and take my profit. However, there is a caveat: if the breakout happens soon (like, in the next 30 days), then I'll just sell half at $12.50 and let the rest ride because that would be a huge signal that we may have nailed the timing for a big breakout.
If you have any questions on this trade, please send them here.
ASO subscribers who missed last week’s video Jam Session where we reviewed activity in our options portfolio from the past week can catch it here.
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