Okay, Uncle Sam…
But back to reality. We have been in a historically low-interest rate environment over the last ten years or so with interest rates currently hovering around an all time low. While the Federal Reverse just raised their overnight interest rates by 25 basis points, we still have barely moved the needle towards normalizing rates.
If the Fed is going to continue somehow to raise interest rates without the market crashing, it is likely we will see and overall rise in not just short-term interest rates (like the Fed funds rate) but also in long-term interest rates (30-year bonds, mortgage rates, etc.).
The best way to get exposure to the longer-term interest rates would be trading TLT, the iShares 20+ Year Treasury Bond ETF. And as always, if TLT options are better than TLT stock, we will be trading options folks.
iShares 20+ Year Treasury Bond ETF
Overnight interest rates are determined by the Federal Reserve, which is an independent privately owned entity that decided on US monetary policy by itself. One of the ways they can “help” control supply and demand is through making credit more readily available for institutions. This is a top-down approach, and as the Fed funds rate decreases, Banks can borrow more money and lend it out to businesses, etc.
There are a lot of bonds out there, and the ones that have the shortest maturity cycle are most affected by this Fed funds rate. However, those with much longer maturity dates such as the 30 Year US Treasury Bond, are more impacted by supply and demand and the outlook for potential economic growth over a longer timeframe.
The best way for investors to get exposure to the rise and fall of interest rates with the longest dates of maturity is through TLT.
We can see 30 Year Bond futures in red/green compared to TLT is pink. These two have a 94 correlation which means they pretty much move tick for tick with one another. We can see TLT prices were moving higher for a while (interest rates going down) but ever since the election have sold off hard (interest rates going up).
If we want to get exposure to these prices, the 30 Year Bond futures are just way too large and we would prefer to trade TLT options to TLT stock if the options are liquid enough for us. Let’s check them out!
Are TLT Options Liquid Enough?
If this is the 20+ year bond ETF, we would imagine there would be a lot of volume and interest here, right? Let’s see how many TLT options contracts exchanged hands yesterday. Anything over a few thousand TLT options would be more than enough.
Way more than enough folks. These are large numbers and represent almost one billion dollars in notional value ($824,500,544).
It is all about demand. If there is demand there is liquidity. Is there enough demand to warrant weekly options instead of just monthly expirations?
Absolutely. Remember, liquidity is the single most important thing to look for before making any investment or trade. TLT options are looking like they will have the proper amount of liquidity for us.
How about the bid/ask spreads? Are they small enough so that we know there is competition for orders?
Absolutely. With bid/ask spreads only a few pennies wide we know that we can get filled at fair market value which will not result in us having to take a loss to execute the position.
Our Favorite TLT Options Trades
We know TLT options are liquid enough for us to trade and invest in. Awesome.
But what kinds of trades should we be looking for?
Our favorite trade in TLT options is to sell call spreads every time TLT rises more than a few dollars. The reason for this?
- We don’t believe interest rates are going to zero
- Call spreads define our risk
Here is an example of a trade that we like:
TLT was up $0.74 yesterday. This fits out criteria for an up move. We would then like to sell a call spread.
Selling this call spread gives us $39 in credit and only costs us $61 in margin requirements. If we were to be right on this trade and TLT doesn’t expire over $119, we would keep the full credit and make a 64% profit.
Wrapping Up TLT Options
They are liquid enough for sure. And they are a tremendous trading vehicle for rising interest rates. Add TLT to your list of things to look at for an investment or trade as you could be trading TLT every day from now on!