TLT Analysis

iShares Barclays 20+ Year Teasury Bond ETF (TLT)

Update 12/22/2016: TLT spent the time I held it toying with the lower boundary of profitability. With expiration eight days away and the low liquidity winter holidays season rapidly approaching, I exited for a smaller profit that was my goal, which is 25% of the potential maxim.

But in a world where 10-year government bonds pay 2.6% a year, a return of 9.5% of maximum is still a significant gain for three weeks, so I have no complaints.

Shares fell by 2.9% over 23 days, or a -5% annual rate. The options position produced a +10.5% yield on debit for a +166% annual rate.

The trading idea came from Fauzia at Dough. I’ve never seen an iron condor structured this way, with a identical shorts on both calls and puts, with extremely wide wings. It’s basically a straddle with defined risk. Most iron condors are strangles with risk defined.

Implied volatility on Fauzia’s trade is a bit below my minimum requirement of the 50th percentile or higher of the annual range.

I shall use the DEC30 series of options, which trades for the last time 32 days hence, on Dec. 30.

Implied volatility stands at 16%, which is in the 48th percentile of its annual range. The price used for analysis was $121.52.

Iron condor, short the $121 calls and long the $128.50 calls,
short the $121 puts and long the $114.50 puts,
sold for a credit and expiring Dec. 31.
Probability of expiring out-of-the-money

JAN Strike OTM Δ
Upper 121 48.4% 54
Lower 121 48.4% 54

The premium is $3.69, which is 49% of the width of the position’s wings.

The risk/reward ratio is 1:1.

Decision for My Account

I’ve entered a position on TLT as described above. The stock at the time of entry was priced at $121.523.

Further analysis after the closing bell

After the closing bell I sat down and tried to understand Fauzia’s interesting trade structure. She included no comment explaining her motivations or reasoning.

So let’s take some back bearings. The big event looming before us all is the December meeting of the Federal Open Market Committee, a two day session with an announcement Wednesday, Dec. 14, on whether or not the money policy body will raise interest rates.

The market for TLT, a fund composed of government bonds, will be impacted by the decision. Market pricing suggests strong expectations that rates will be raised.

I infer from the calendar of events that Fauzia expects TLT to remain within a tight range between now and the FOMC announcement.

That explains the narrow spread between the short calls and short puts, the space that defines the zone of profit. Since both are a $121, Fauzia’s trade structure has no zone of maximum profit except for one price point — $121. So we must look elsewhere for the money-making potential of this trade.

The answer, of course, is time decay. The trade is structured so that the net short positions gains value with increasing magnitude each passing day It was only 32 days until expiration when the trade was placed. Expiration happens a bit more than two weeks after the FOMC announcement.

That being so, the profit will come from the high premium, $3.69 before fees, and the trader’s expectation is that the value of the debit need to exit the trade will be less than $3.69. That difference — $3.69 minus the exit debit — is where the profit is.

Where does that happen? At the long wings, of course. And they are very wide, $7.50 in either direction. The trade can take a 6.2% move either way and still be profitable.

I feel quit confident that Fauzia’s intent is to exit before the FOMC announcement.

The fact that the premium is 49% of the wings means that this is an extreme verson of an iron condor variation known as the chicken iron condor. See an 11 minute video explaining the trade here.

One oddity. The video suggests using chicken iron condors to play earnings announcements because they provide such a wide zone of profit. TLT as a bond ETF has no earnings announcements. But when I think it over, an FOMC interest range announcement is an close to earnings as we’ll get with a fund like ETF.

By Tim Bovee, Portland, Oregon, Nov. 28, 2016


2 thoughts on “TLT Analysis

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