Quarterly Outlook
Q4 Outlook for Investors: Diversify like it’s 2025 – don’t fall for déjà vu
Jacob Falkencrone
Global Head of Investment Strategy
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Investing with options - bonds? TLT!
Koen Hoorelbeke
Investment and Options Strategist
Summary: As the allure of bonds re-emerges, the spotlight also shines on sophisticated investment methods like options on bond ETFs, especially TLT. Current yields have reshaped bonds into a promising investment medium, bestowing them with merits such as comparatively lower risk than stocks, bolstered diversification, and a dependable income flow resilient to economic fluctuations.
Investing with options -bonds? TLT!
Introduction
Over the past years, bonds remained somewhat in the shadows for many investors, largely due to the prevailing ultra-low interest rate environment that rendered their yields minuscule. However, the last two years have seen a distinct transformation. For instance, in the US, the 10-year yield surged from a humble 1.15% to a noteworthy 4.75%. And because of the inverse correlation between yields and bonds, the bonds or in particular the TLT bond ETF, is at multi-year lows:
If you've been following our publications, you'd have noticed a series of articles on bonds in the past few weeks, reflecting their renewed significance as highlighted in our Q4 Quarterly Outlook. But how does one navigate this bond resurgence? Enter TLT, a prominent bond ETF. This article will guide you through the intricacies of leveraging options on TLT, offering strategic insights for both long-term investment and adept trading in the bond market.
Related Articles:
- Bonds - 12 Oct 2023: Bond ETFs (UCITS): why and how
- Bonds - 11 Oct 2023: Bond ETFs: why and how
- Bonds - 09 Oct 2023: The bond market: fears of war and inflation
- Bonds - 05 Oct 2023: The bond market is waiting for nonfarm payrolls
- Bonds - 04 Oct 2023: Consider bonds to diversify against stock market risk
- Quarterly Outlook - 03 Oct 2023: Time to (re)consider bonds
- Quarterly Outlook - 03 Oct 2023: The road to a bond bull market is paved, although challenges remain
- Quarterly Outlook - 03 Oct 2023: Bond. Long bond(s)
Trade Setups for Investors
Investors, with a longer-term perspective, might be keen on utilizing strategies that capitalize on broader market trends. Here are two primary setups depending whether you're bullish or bearish on bonds:
1. Bullish Long Call:
A bullish long call strategy involves buying a call option with the belief that the underlying asset, in this case bonds, will increase in value. This strategy benefits from a rise in bond prices and is limited to the premium paid if the trade doesn't work out.
The Bullish Long Call setup presented in the screenshot above is designed for investors who anticipate an upward movement in the TLT (iShares Barclays 20+ Year Treasury Bond ETF). Here's an analysis of the trade:
- Underlying Asset: iShares Barclays 20+ Year Treasury Bond ETF (TLT) is currently trading at $86.11.
- Option Details: This setup involves buying a call option expiring on September 20, 2024, with a strike price of $77. The premium for this option is $13.35, resulting in a total cost (debit) of $1,335.00 USD.
- Profit Potential: The beauty of a long call is the potential for unlimited profit. As showcased in the risk graph, as TLT's price rises, potential profit increases without a ceiling.
- Risk Analysis: The maximum risk or loss an investor can face in this setup is the premium paid, which is $1,335.00 USD. This occurs if TLT closes below the strike price of $77 by the expiry.
- Breakeven Point: For this trade to break even, the TLT needs to reach a price of $90.35 by expiration (strike price plus premium).
- Option Greeks:
- Delta: 0.7951, indicating that for every $1 move in the underlying asset, the option will move approximately $0.7951.
2. Bearish Long Put:
Opting for a bearish long put strategy means purchasing a put option, anticipating a decline in the value of bonds. This approach capitalizes on falling bond prices and, similar to the long call, the maximum loss is the premium paid.
The Bearish Long Put strategy depicted in the image above is for investors who anticipate a downward movement in the TLT (iShares Barclays 20+ Year Treasury Bond ETF). Here's a concise breakdown:
- Underlying Asset: TLT is trading at $86.19.
- Option Details: The strategy involves purchasing a put option with an expiry date of September 20, 2024, and a strike price of $99. The option's premium is $13.60, making the total cost $1,360.00 USD.
- Profit Potential: The potential profit from a long put is significant but not unlimited, as it's capped by the underlying reaching zero. The graph visually displays the increasing profit as TLT's price declines.
- Risk Analysis: The maximum risk an investor is exposed to is the premium paid, or $1,360.00 USD. This is the maximum loss if TLT closes above the $99 strike price at expiration.
- Breakeven Point: TLT needs to drop to $85.40 by expiration for this trade to breakeven (strike price minus premium).
- Option Greeks:
- Delta: -0.8038, signifying that for each $1 decrease in the underlying asset, the option value increases by approximately $0.8038.
Trade Setups for Traders
For those with a shorter time horizon and a more tactical approach, these setups offer flexibility across different market conditions. Following are 3 trade-setups depending your (short-term) outlook for bonds, and the TLT-ETF in particular:
1. Bullish Put Credit Spread:
This strategy involves selling a put option while simultaneously buying another put option with a lower strike price on the same underlying asset. The goal here is to profit from the premium difference, ideally in a rising or neutral market.
Overview
- Underlying Asset: TLT (iShares Barclays 20+ Year Treasury Bond ETF) is trading at $86.19.
- Option Details:
- Short Put: Selling a put option with an expiry of November 17, 2023, and a strike price of $85.
- Long Put: Buying a put option with the same expiry but a lower strike price of $80.
- Net Premium: Receiving a credit of $121.00 USD.
- Profit Potential: The maximum potential profit is the net credit received, which is $121.00 USD.
- Risk Analysis: The maximum potential loss is the difference between the strike prices minus the net premium received. In this case, it's $379.00 USD ([$85 - $80] x 100 - $121.00).
- Breakeven Point: The breakeven point for this strategy is $83.79, calculated as the higher strike price minus the net premium received.
- Option Greeks:
- Short Put: Delta: -0.4051, Theta: -0.0305
- Long Put: Delta: -0.1426, Theta: 0.0218
2. Neutral Iron Condor:
The Iron Condor is a strategy that involves four options: selling a lower strike put, buying an even lower strike put, selling a higher strike call, and buying an even higher strike call. This strategy profits in a sideways market where the underlying asset price remains between the two sold strikes.
Overview
- Underlying Asset: TLT (iShares Barclays 20+ Year Treasury Bond ETF) with a current price of $86.10.
- Option Details:
- Bull Put Spread:
- Short Put: Selling a put option with an expiry of November 17, 2023, and a strike price of $82.
- Long Put: Buying a put option with the same expiry and a lower strike price of $77.
- Bear Call Spread:
- Short Call: Selling a call option with an expiry of November 17, 2023, and a strike price of $91.
- Long Call: Buying a call option with the same expiry and a higher strike price of $96.
- Bull Put Spread:
- Net Premium: Receiving a credit of $105.00 USD.
- Profit Potential: Maximum Profit: The net credit received, $105.00 USD.
- Risk Analysis: Maximum Loss: The difference between the wider strike prices minus the net premium received. Here, it's $395.00 USD ([$91 - $82] x 100 - $105.00).
- Breakeven Points:
- On the lower side, $80.95 (short put strike minus net premium).
- On the higher side, $92.05 (short call strike plus net premium).
3. Bearish Call Credit Spread:
By selling a call option and buying another call option with a higher strike price on the same asset, traders aim to profit from the premium difference in a declining or neutral market scenario.
Overview
- Underlying Asset: TLT (iShares Barclays 20+ Year Treasury Bond ETF) with a current price of $86.10.
- Option Details:
- Short Call:
- Action: Selling (Sell to Open) a call option.
- Expiry: November 17, 2023.
- Strike: $88.
- Price (credit): $1.52 - $1.54.
- Long Call:
- Action: Buying (Buy to Open) a call option to hedge against the short call.
- Expiry: November 17, 2023.
- Strike: $93.
- Price (debit): $0.39 - $0.40.
- Net Premium: A credit of $1.15 per spread, resulting in $115.00 USD.
- Short Call:
- Profit Potential: Maximum Profit: The net premium received, i.e., $115.00 USD.
- Risk Analysis: Maximum Loss: Difference between the two strike prices minus the net premium received. In this case, $385.00 USD ([$93 - $88] x 100 - $115.00).
- Breakeven Point: Short call strike plus net premium, which is $89.15.
Conclusion
The bond market's evolving landscape has opened doors to a myriad of trading opportunities. By aligning strategies with market views and risk appetite, both investors and traders can navigate this environment with precision. As always, each trade setup comes with its risk-reward dynamics, making it crucial to be well-informed and adaptable.
Related articles:
- Bonds - 12 Oct 2023: Bond ETFs (UCITS): why and how
- Bonds - 11 Oct 2023: Bond ETFs: why and how
- Bonds - 09 Oct 2023: The bond market: fears of war and inflation
- Bonds - 05 Oct 2023: The bond market is waiting for nonfarm payrolls
- Bonds - 04 Oct 2023: Consider bonds to diversify against stock market risk
- Quarterly Outlook - 03 Oct 2023: Time to (re)consider bonds
- Quarterly Outlook - 03 Oct 2023: The road to a bond bull market is paved, although challenges remain
- Quarterly Outlook - 03 Oct 2023: Bond. Long bond(s)
Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.
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