Let's look at a evenhanded way to play Friday's jobs data on the
presumption that not much has changed, especially the Fed's view of
things. We are going to use an iron condor on the belief that rates
will remain in a range but take advantage of the recent volatility.
The markets are inscrutable, especially when they are manipulated
by gods on high that want to do right but have no clue as to the
repercussions of their actions. So far the TARP, QE, and other
sundry programs have done...cough, cough...more good than bad. We
have seen a slow slog of improving economic data, but nothing to
speak of in terms of improving prospects for middle class workers
or recently graduated students. Debt, debt, debt. Even the Abe's
experiment seems to be backfiring.
But let's drill down to a smaller time and a place closer to home.
Yield on the 10-Year Note has jumped some 34 basis points over the
past three weeks. At a rate of 2.14% T-Notes suddenly pay more than
(INDEXSP:.INX), which yields 2.10%. And note the equity risk as
dividend payers such as
Procter & Gamble
) have nosedived on threats of higher rates.
Rates Are Bound
With the Fed being bound between weak employment and weak top-line
revenue growth, I don't expect, and Ben Bernanke has not, projected
any bold move in hiking rates. Expect yield on the 10-year to
remain between 1.75%-2.20% for the next three months. Given the
historically low numbers, this range might seem expansive. However,
they are priced as such, meaning there is an option strategy to
take advantage of what is likely to be a range-bound market. But
people have been on pins and needles regarding what the next move
will be, and mixed messages from the data, and opposing views from
hawks such as Richard Fisher and doves like Janet Yellen, are
causing increased consternation. This has helped elevate the
implied volatility of 26% over the past week. This shoots the IV
well over the realized volatility, the first time we have seen that
in three months.
I think this gets resolved by an underwhelming move that leaves
rate on the 10-year note between 2.10% and 1.90% following
tomorrow's jobs report. To play this theme I'm using as a proxy the
iShares Barclay's 20+ Year Treasury Bond
(NYSEARCA:TLT). (The name is a misnomer; the duration of these
bonds is 13 years.)
Why Use an Iron Condor?
An iron condor involves the simultaneous sale of both a call spread
and a put spread, typically using out-of-the-money options which
"surround" the current underlying price. If the underlying expires
within the range, one collects the premium as profit. While not
exact, the TLT will trade down to $113 to reflect a 2.20% yield and
up to $118 to reflect a 1.85% yield.
For some wiggle room, I am selling two out-of-the-money spreads.
On the put side:
- Sell open 10 June $112 puts at $0.70 a contract
- Buy to open 10 June $110 put at $0.30 a contract
This is a $0.40 net credit.
And on the call side:
- Sold to open 10 June $118 calls at $0.60 a contract
- Bought to open 10 June $120 calls at $0.25 a contract
This is a $0.35 net debit.
All told, the iron condor collects a total of $0.70 net premium.
This is the maximum profit that would be realized if shares of TLT
are between $112 and $118 on the June 22 expiration. The maximum
loss is $1.30 which would be incurred if shares of TLT are below
$110 or above $120 on the June expiration. This is a probability
play in which the payoff is lower than the loss, but the likelihood
of it making money is greater than it being a loser. And it is a