June 22nd, 2009

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Short covering ahead of FOMC

Weaker stocks and a stronger dollar promoted safe haven buying in Treasuries.  Perhaps the sell in May mantra for equities is finally coming into full swing.  As is usually the case during this time of year, portfolio rebalancing (and seasonal overweighting of Treasuries) are directly benefiting bonds and notes.

Bond and note traders are preparing for the next FOMC announcement on the Fed funds target rate.  The Fed is widely expected to keep rates at the current near zero range, but traders would like to hear about their expectations for the remainder of the year.  Most importantly, traders will be looking for clues as to if and when the Fed has any plans to begin increasing rates. 

The Fed funds futures markets seems to be pricing in the possibility of a rate hike before December, and a much better probability of an increase in the first quarter of 2010.  Some analysts, on the other hand, feel like this projection is a bit aggressive and expect the Fed to leave rates unchanged for the foreseeable future. 

The Fed purchased $7.497 billion of the $20.73 billion offered by dealers in the 4 to 7 year maturity range.  However, in the large scheme of things this likely didn't have a large impact on today's trade.  However, the onslaught of offerings due this week may have kept a cap on the buying. 

While today's rally was impressive, given the large number of short positions being held in this market according to COT data, the short covering rally could have been much larger.  I suspect that traders are focusing on $100 billion plus in Treasury securities ranging from a record $40 billion in 2-year notes and another $27 billion in 7-year notes, that are being auctioned this week. 

We still see resistance in the long bond near 118 and believe that it is a real possibility at some point before the FOMC announcement on Wednesday.  In the meantime, support should be found near 115'12 then again at 114'31.  The 10-year note is facing resistance near 115'24 but we ultimately think that the market will see 117'0.  The 5-year note may run into trouble near 114'10 but we think that 115'25 is the next target for the bulls.

* Due to time constraints and our fiduciary duty to put clients first, the charts provided in this newsletter may not reflect the current session data.  However, market analysis and commentary does.  Charts provided by Track 'n Trade, Gecko software.

**Seasonality is already be factored into current prices, any references to such does not indicate future market action.

Treasury Bond and Note Option Trading Recommendations

**There is unlimited risk in naked option selling.

May 21 - Our clients were recommended to sell the July bond 112 puts for 25, fills ranged from 25 to 23.  This option traded at just 10 ticks early in the day but an explosion in volatility allowed us to sell the option for a considerate amount of premium.  The premise of the trade is to profit from declining volatility and or positive bond movement.  The strike price is over 7 handles out of the money to give the position a considerable amount of room for error but of course the risk is unlimited below 112. 

May 27 - We recommended that our clients sell the July bond 109 puts for 25 or better, some fills were reported near 30. 

• ·         May 28 - For those holding both the 112's and the 109's we lowered the delta of the trade by selling the July 123 calls for 30 and buying the 110 puts for 56.  If we detect stability, we will salvage what we can for the long put and hold the strangle. 
• ·         May 29 - we sold the long 110 puts this morning for 30 and are holding the lopsided strangle looking for a decrease in volatility and accelerated premium erosion.
• ·         June 5 - We bought back the 123 calls for 5 ticks to take a profit on that leg
• ·         June 8 - We sold the July 119 calls for about 30 and the 118's for about 32 to strangle the market (AKA stop the bleeding)
• ·         June 10 - We rolled the July 10 puts from the 112 puts to widen the strangle, we gave up about 41 ticks in premium to do it.
• ·         June 12 - We recommended that our clients buy back the 109 puts for 8 ticks.
• ·         June 15 - We recommended that our clients (with this version of the spread) buy back the 110 puts for 8 ticks.

Treasury Bond and Note Futures Trading Recommendations

May 26 - Buy the June 5-year note at 116'05 or better ( you should have rolled this into the September contract, which would be equivalent to an entry near 115'06)

• ·         May 29 - Look to liquidate this trade near 115'25
• ·         June 4 - We recommended readers with this position to purchase a 114 put for insurance, hopefully if you have this trade on you were able to do so.  Doing this would limit the risk on the trade to approximately $1,500 before commissions and fees. 

Eurodollar Futures Trading Recommendations

**There is unlimited risk in trading futures.

Flat

*Due to the volatile nature of the futures markets some information and charts in this report may not be timely.

There is substantial risk of loss in trading futures and options.