A New. Treasury Trading Strategy. How to Profit From Interest Rate Volatility

Transcription

1 A New Treasury Trading Strategy How to Profit From Interest Rate Volatility

2 Converting Interest Rate Volatility Into Healthy Profits Dear Trader, Most people don t think of the multi-trillion-dollar Treasury market as a place to make substantial profits. After all, yields have ranged between just 2.54% and 4.86% over the last five years. That s not going to make anyone a lot of money. Or is it? I have been in the investment business since I was first licensed in I learned the business working for a small commodity broker. In the mid-1990s, I began managing the futures trading desk for Piper Jaffray in Minneapolis. After that, I founded a Florida-based firm, GSV Futures, which traded futures for individual speculators as well as institutional level strategies for larger investors and hedgers. In 2006, I sold the firm and began to work for Harry and Rodney shortly thereafter. In this manual, I will show you how to generate healthy profits by trading options that capitalize on the relatively small moves in interest rates on U.S. Treasury bonds. What s more, I ll show you how to bring in those solid gains with relatively short-term trades and without putting too much money at risk. You see because of risk, small moves in interest rates make for big price moves in longer term interest rate products, like U.S. Treasury bonds and related securities. That s because the risk level increases the longer a bond is held. And that elevated risk must be compensated with higher yields and lower prices. When yields go up, the value/price of T-bonds goes down and vice versa. Think of it as a teeter-totter with the Fed as the fulcrum. Interest rates are on one side, prices are on the other and time extends in both directions from the center. Time Time Prices Interest Rates When the Fed changes its overnight borrowing rate (Fed funds rate), the increase or decrease is typically very small, but think of the teeter-totter example. Increases or decreases in interest rates are very small near the center (i.e., in the short-term), but their effect grows exponentially the farther out you go on the board (i.e., farther out in time). 2 The Fed

3 That s how a relatively small move in overnight rates creates a dramatic shift in long-term prices and yields. And that s how we ll generate big profits, without too much downside risk. Our proprietary system provides clear entry and exit signals designed to maximize gains. It also contains reliable risk controls to preserve as much of our initial investment as possible when a trade goes wrong. During two years of theoretical back-testing and five months of active trading, the Dent Digest Trader system has an impressive win-rate of more than 72%. And in those last five months, our average gain has been above 87% while our average loss has been about 50%. Essentially, we re nearly doubling our money about three-quarters of the time! It is also worth mentioning that the system is setup to manage risk and not let our options expire worthless. We see that in the fact that our largest loss to date has been 52.5%. So even in the worst-case scenario, we still held onto half our money. It s More Than Just the Fed Because Fed policies have the biggest impact on rates (and, therefore, on prices), quite often just the perception of possible Fed action is enough to move the market. That s how economic news, government statistics and even simple Federal Reserve comments can impact interest rates and asset prices by influencing where investors invest. You see when investors believe the Fed will act a certain way, they move in or out of Treasury bonds, depending on the expected action. What s important here is the surprise factor. It doesn t necessarily matter whether the Fed raises or lowers interest rates. What really matters is how that action compares with what the market expected. For example, if the Fed raises rates more than expected or drops them less than expected, that would be a positive surprise, and investors will flood into Treasurys. Conversely, if the Fed increases rates less than anticipated or cuts them more than anticipated, that would be a negative surprise, and investors will pull out of Treasurys. Investors move in or out of bonds, depending on the risk level of the equity markets. If, for instance, geopolitical events cause substantial volatility in the stock market, investors will flee to the relative safety of Treasurys. These movements in or out of the Treasury market have a strong impact on rates. And that s why Dent Digest Trader focuses on what is moving the markets at any given moment. Strategy Summary Our Dent Digest Trader strategy is very simple: we seek to profit from temporary interest movements that approach the limits of so-called mini-ranges at the long end of the Treasury yield curve. We look for anything that pushes rates close to the parameters we ve established in our Dent Digest Trader system. This is considered a countertrend. Then we take a position that will produce strong returns when the so-called countertrend reverses. If you re familiar with the concept of swing trading, that s essentially what this is. We re taking advantage of short-term price fluctuations within a clearly defined range. You may have already seen the chart below, as it is frequently used by Harry Dent to demonstrate the predictable movement of Treasury Note interest rates over time. 3

4 This chart is a perfect illustration of how our strategy works. In its simplest form: we buy calls when prices hit the bottom of our channel (not the one shown below), and we buy puts when prices hit the top. Our strategy is based on the 20-Year Treasury Bond and our channel covers a much shorter timespan. The Dent Digest Trader strategy is easy to follow, and the instructions included in each Trade Alert are very specific, as detailed below. One of the best parts of the strategy is its ability to maximize gains while minimizing risk. By trading options, we magnify our potential gains well above what could be gained from long positions. Additionally, losses are limited to the price of the options contracts we buy, regardless of what happens to the underlying ETF. The maximum loss is the value of the options you purchase and we are only buying options. And since we are talking about maximum loss, there will be times when the system is wrong. Employing stoplosses on options is nearly impossible, but Treasury Trader will alert us when to get out, even if we are wrong. That way, instead of losing the entire options premium, we can at least recoup part of it. 4 The Plan We have a straight-forward plan for profiting off of short-term rate movements, so let me start with the basics. Securities: We ll be trading put and call options on ProShares UltraShort 20+ Year Treasury (NYSE: TBT), an Exchange-Traded Fund designed to return two times the inverse (-2x) of the daily performance of the Barclays U.S. 20+ Year Treasury Bond Index. For example, if the bond index moves down 1% in a single day, TBT seeks to move up 2%.

5 After extensively testing various securities, I found that TBT worked the best because it is leveraged and very liquid (average daily volume exceeds 3.5 million units traded per day). It also offers weekly options available, which provide flexibility with expiration dates. Note: This strategy looks at short-term moves, so at times it may appear to trade counter what is being discussed in Boom & Bust, which is focused on longer term interest rate trends. Position Size: We will carry only one position at a time in our portfolio. Although the total size of each position you take depends on your personal comfort level, we recommend buying your options contracts in increments of two. That way you won t have any trouble executing trades when we advise exiting half your position. Holding Period: Trade lengths will range from less than a week to just over two weeks, with an average holding period of approximately 11 days. By maintaining a relatively short holding period, we can buy options that are cheaper, because there is less of a time premium involved. Trade Frequency: You can expect approximately two trades per month, with each trade including separate opening and exiting signals. These will be conveyed via Dent Digest Trader Trade Alert issued whenever a trade is triggered. Trade Execution: Our Dent Digest Trader Trade Alert will contain explicit instructions for executing each trade. To make things as easy as possible, each alert will have an Action to take that can be read directly to your broker. A typical trade order will look like this: Action to take: Buy to open October 10, 2014 $60-strike put options on the ProShares UltraShort 20+Year Treasury ETF (NYSE: TBT) at the market. The current ask price for this contract is $2.17, meaning each contract can be bought with a market order for $217. Details: Securities: ProShares UltraShort 20+Year Treasury ETF Stock Symbol: TBT Option Type: Put option Expiration Date: October 10, 2014 Strike Price: $60 Order Type: Buy to open at the market Target Entry Price (based on current ask price): $2.17 Symbols (On TradeMonster): TBTV1014C Entry Strategy: Make certain your order is executed within the first 30 minutes of tomorrow s opening bell. Trade Timing: Your opening trade will usually be placed the following day near the opening bell. I like to wait a few minutes after the open to allow for the options to open and the spreads to narrow, but make sure your order is executed with the first 30 minutes. Closing trades will typically be handled in the same fashion. However, on occasion, you may be asked to exit the position immediately, depending on how quickly the market is moving. 5

6 6 Glossary You will be required to open an options account if you plan to trade this strategy. If you re not already familiar with trading options, here s a brief glossary of some of the terms I ll be using. I know, it can be confusing but rest assured, I will make sure you are positioned correctly whenever a Dent Digest Trader Trade Alert is issued. Options Terms: 1. Call Options (aka Calls ) An options contract that gives the buyer the right to BUY stock (read: option, or choice) at a specified price (the strike price ). 2. Put Options (aka Puts ) An options contract that gives the buyer the right to SELL stock at a specified price. 3. Strike Price (aka Strike ) The fixed price at which stock will be bought or sold if the option is exercised. 4. Expiration Date The date on which the options contract expires. For stock options, it is usually the third Friday of the expiration month. Many index options expire the day before, on Thursday. 5. Premium The dollar amount required to purchase a call or put (debit), or the amount received from selling a call or put (credit). The buyer pays the debit; the seller receives the credit. 6. Market Order An order to buy or sell an option at the current price. (You cannot determine the specific price you re willing to pay.) The advantage of a market order is that it s guaranteed to execute; the disadvantage is that you don t know the exact price until you receive a confirmation. Use market orders when execution takes priority. 7. Limit Order An order to buy or sell an option that allows you to choose the maximum price you re willing to pay (if buying) or minimum price you re willing to receive (if selling). The advantage of a limit order is that it prevents any unfavorable prices. The disadvantage is that the order may not execute. Pricing and Fees It s likely you already have a brokerage account, possibly even one that you currently use to trade stock options. But if you don t have your account established, I m providing a list of brokers you can look into. While we have no relationships with any of these brokers, they allow options trading on stocks and ETFs from a common brokerage account. Even if you already have your account established, I d recommend calling your broker and confirming that it s setup to trade options. You may need to fill out a one- or two-page form indicating what options strategies you d like to trade. I will only recommend basic options strategies: buying calls or buying puts. Broker Contact Information: TD Ameritrade Interactive Brokers Charles Schwab Fidelity

7 E*Trade OptionsXpress EverTrade trademonster Pricing is standard to any equity options contract. An option represents control of 100 shares of the underlying stock or security. So for example, a TBT option priced at $1.78 per contract would cost $178 ($1.78 x 100 units), plus commissions. Please review each broker s commissions and fees before opening a trading account as they vary from firm to firm. And make sure to tour the trading platforms for ease of use. Once you ve decided on a broker and opened an account, you ll be ready to trade. Just keep an eye on your inbox for my Dent Digest Trader Trade Alert, and we ll start converting interest rate volatility into healthy profits. Good Trading, Lance 7

8 Publisher...Shannon Sands Editor...Lance Gaitan Managing Editor...James Wells Dent Digest Trader 55 N.E. 5th Avenue, Suite 200 Delray Beach, FL USA, USA Toll Free Tel.: (888) Legal Notice: This work is based on what we ve learned as financial journalists. It may contain errors and you should not base investment decisions solely on what you read here. It s your money and your responsibility. Nothing herein should be considered personalized investment advice. Although our employees may answer general customer service questions, they are not licensed to address your particular investment situation. Our track record is based on hypothetical results and may not reflect the same results as actual trades. Likewise, past performance is no guarantee of future returns. Certain investments such as futures, options, and currency trading carry large potential rewards but also large potential risk. Don t trade in these markets with money you can t afford to lose. Delray Publishing expressly forbids its writers from having a financial interest in their own securities or commodities recommendations to readers. Such recommendations may be traded, however, by other editors, Delray Publishing, its affiliated entities, employees, and agents, but only after waiting 24 hours after an internet broadcast or 72 hours after a publication only circulated through the mail. Also, please note that due to our commercial relationship with EverBank, we may receive compensation if you choose to invest in any of their offerings. (c) 2014 Delray Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. This Newsletter may only be used pursuant to the subscription agreement. Any reproduction, copying, or redistribution, (electronic or otherwise) in whole or in part, is strictly prohibited without the express written permission of Delray Publishing. 55 N.E. 5th Ave, Suite 200, Delray Beach, FL