Traders have been increasingly eager to speculate on the future direction of interest rates. The volatility implied by options on 2-, 5-, 10-, and 30-year Treasury notes and bonds has lifted the Merrill Lynch MOVE Index above 110. For perspective, note that the recent high of 116 occurred on May 6, the infamous “flash crash” day.
Despite the well-known concerns many have about the complexity of leveraged ETFs and options on them, speculators haven’t hesitated to express their views by trading significant volume in options on (NYSE:TBT), the ProShares UltraShort 20+ Year Treasury ETF. The table below shows call prices and open interest for (NYSE:TBT) options expiring in September.
The open interest at the 33 strike represents, at current prices, about $1.9M – of course, many of these contracts were probably bought at much higher levels. This call activity strikes me as remarkable, considering that TBT’s momentum has barely slowed, with no sign of a reversal; I don’t much care for technical analysis, but given that some of the traders buying (NYSE:TBT) calls presumably do, I wonder what it is they think they’re seeing? Is this just an expensive round of bottom-fishing?
We’re taking a more measured approach. Our iron condor options newsletter service has never really been just about that one type of options spread: we also discuss topics like delta hedging, the theory behind option selling strategies, and experiments with new strategies. We added a new experimental component last week, trading options on interest rates (via the (NYSE:TLT) ETF).
We have a trade open right now for October expiration that will be dynamically delta-hedged as necessary. Instead of staking out a plain directional thesis, we’re more interested in trading the difference between the elevated implied volatility in these options and the quieter historical volatility. (NYSE:TLT) October at-the-money puts have an implied volatility above 21%, while the ETF has exhibited volatility recently of about 19% annualized. Since 2003, the average 21-day historical volatility of the ETF has been just 11%. We are pretty comfortable, therefore, with a bet on things quieting down a bit from here, but even if implied volatility continues to lift, we’ll be profitable at expiration as long as the volatility exhibited by the underlying is less than 21% or so. This sort of approach won’t achieve dramatic returns, but it also frees us from depending on some miraculous reversal, news event, or economic surprise.
Condor Options is a New York-based research and trading firm focusing on market neutral trading strategies. Condor Options publishes an educational newsletter teaching iron condors and volatility-based options trading, with a focus on risk management and quantitative analysis.