Hedging Treasury Risk –

If you’re stubborn about holding Treasuries with the pending rate hike and you or your manager doesn’t hedge downside risk you’ll have no one to blame but yourself.

Using an option collar provides protection by selling a call option against your position and using the collected premium to purchase a put option to define downside risk.

1) Benefits

  • Risk is defined on the trade and for the duration of the trading period
  • Loses will be limited when the Fed finally engages with rate hikes
  • If the market stays the same you’ve collected approximately as much time premium as you’ve purchased

2) How it works, start by checking the chart

Click here for a current chart

Screenshot_929

3) Check your ranges

To determine realistic risk reward levels consistent with the duration of the trade. In this example I’m trading the September 10 Year which goes off the board 21, August 2015 or 18 days from the 3 August 2015 entry.

Click here for current ranges

Screenshot_927

4) Establish your position.

  • Long the September T-Note at 127 26/32
  • Sell the 128 32/64th call against the long position collecting $335.94
  • Using the collected premium buy the 126 32/64th put paying $298.06

Screenshot_928

5) To experiment with any potential outcome for this trade

Click here to open the corresponding risk/reward spreadsheet, enable it, enter any price into cell C-2

6) Worst case scenario

Rates skyrocket, Treasuries sell off hard to 110 0/32nds for a loss in contract value of -17,812.50 or – 13.93% but because we’re hedged our loss was limited to -$1,266

Screenshot_924

7) To confirm

A) Enter 110 0/32 in cell C-2
B) Net loss shows in cell E-2
C) Net liquidating value shows in cell E-3

Screenshot_930

8) The market stays the same you’ve collected your credit premium of $47 plus your interest income.

A) Enter 127 26/32nds in cell C-2
B) Net loss shows in cell E-2
C) Net liquidating value shows in cell E-3

Screenshot_931

9) Rates move lower, Treasuries rally, the position is called away at a $734 profit plus your interest income and we can reestablish the position immediately. 

A) Enter 2,000 in cell C-2
B) Net loss shows in cell E-2
C) Net liquidating value shows in cell E-3

Screenshot_932

For more advance traders we can write a put below the market for reentry where the only way we could be delivered a position is at a better price,  if the market never goes down to the strike we keep the premium.

Example the 127 put is nearly a full point below the market with a time decay of 0.06% per month or 7.24% annually (far more than the interest income)

If delivered a position you can collar it explained above

Or

You can write a call above the market for example 128 16/32 collecting 0.07% per month or 8.5% annually ,the only way the position can be called away from you is at a profit 0.54% or you were paid 0.7% for that month to sell it at a profit (in at 127 26/32nds out at 128 12/32nds).

Using this strategy the worst thing that will happen to you is you would own a bond that you would have bought or already owned anyway.

Contact me for more information on yield enhancement

These strategies can be traded in any liquid market, crude oil and grains have the highest premium currently relative to contract value.
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Click here for contact details

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RISK DISCLOSURE STATEMENT

PROGRAM AVAILABILITY IS DEPENDENT ON YOUR COUNTRY OF RESIDENCY AND FINANCIAL STATUS

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. EXAMPLES OF HISTORIC PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR ARE LIKELY TO OCCUR.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT.

IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADE PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF THE HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

BID/ASK SPREADS, BROKERAGE COMMISSION, CLEARING, EXCHANGE AND REGULATORY FEES WILL HAVE AN ADVERSE IMPACT ON THE NET OVERALL PERFORMANCE OF YOUR ACCOUNT. PRIOR TO MAKING A DECISION TO PARTICIPATE IN ANY INVESTMENT MAKE SURE YOU FULLY UNDERSTAND THE FEES ASSOCIATED WITH TRADING.

THE INFORMATION PROVIDED IN THIS REPORT CONTAINS RESEARCH, MARKET COMMENTARY AND TRADE RECOMMENDATIONS. YOU MAY BE SOLICITED FOR AN ACCOUNT BY ONE OF OUR REPRESENTATIVES OR EMPLOYEES. IT SHOULD BE KNOWN THAT THE REPRESENTATIVES OF OUR FIRM MAY TRADE FUTURES AND OPTIONS FOR THEIR OWN ACCOUNTS OR THOSE OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS MARGIN REQUIREMENTS, RISK FACTORS, TRADING OBJECTIVES, TRADING INSTRUCTIONS, TRADING STRATEGIES, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE LIQUIDATION OR INITIATION OF FUTURES OR OPTIONS POSITIONS THAT DIFFER FROM THE OPINIONS AND RECOMMENDATIONS FOUND IN THIS REPORT.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES.

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Asset Investment Management

Family Office, Advisors

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