Back on May 12, we suggested investors buy a straddle in TLT, the ETF that mimics the returns of US government bonds with maturities in excess of 20 years. This was not a directional call but one designed to take advantage of the extremely depressed level of interest rate volatility. At the time, the momentum was for higher prices but prices were a bit extended. As a result, we decided to trade volatility instead of direction. As it turned out, the trend in higher prices continued so TLT continued to rally.
When buying a straddle, the investor wants the price to take off in any direction and not look back. For a moment there, it looked like that phenomenon may be taking place. But a few things happened that give us pause on the bullish move. Firstly, the rally stopped at an old high, suggesting that investors may be selling at the $132 price level. This is a level that super bond bulls had been buying before. The second is that Fed Head Powel suggested they were prepared to lighten up if the economy needs it. We do not like the fact that the Fed may blink. If they indeed loosen what we think is already loose monetary policy, we think short-term interest rates will fall and long-term interest rates will rise. This means TLT may be about to give back its gains. As a result, we think investors should close out the TLT vol trade. TLT closed trading at $130.93 and the price of the straddle closed trading at $9.58. Selling at these levels will lock in a gain of $178. Not as much as we had hoped, but we will take it.
