November 19th, 2008

See me in the latest issue of "Technical Analyst", Trading Volatility with the VIX

Large drop in inflation equates to plummeting yields.

News of the largest drop in consumer prices prompted Treasury bears to rethink their positions and invigorated the bulls.   The spike in the long bond was fierce and unforgiving.  While the market seems to have overdone itself on the session, we may be headed for a retest of the September highs.  Nonetheless, should this be the case the odds seem to favor a quick reversal.   

Talk of another global coordinated rate cut also came into play.  However, it is likely that the market will price in the rate cut prior to it ever occurring as.  Therefore, one shouldn't look to be a buyer simply because the rate cut is becoming a reality.   

Traders were eager for the FOMC minutes which were released at 2 pm Eastern Standard Time but the news turned out to be a relative non-event.  According to the minutes, the Fed is now projecting the unemployment rate to reach the mid 7% range in 2009. While this news is supportive to Treasuries, it isn't necessarily a surprise.   It seems as though after another session or two of a catch up rally, the Treasuries are apt to run out of buyers. 

Volume was said to be thin and the trade "sloppy".  I can't blame traders for wanting to sit this one out.  The auto industry bail out hearing along with constant Fed chatter has left market participants queasy at best.  As a result, yields on the short end of the curve have made their way lower to levels last seen in mid-2003.   Adding fuel to the fire, PIMCO's Bill Gross was calling for further Fed rate cuts. 

With equities taking a dive, the negative correlation between Treasuries and Stocks is coming back into play.  I am looking for a near-term reversal in each of these markets within the next week.  However, the timing and the magnitude of the moves prior to the trend change is uncertain.  In such volatile markets, both the uncertainty and the risks are high.

From a purely technical standpoint, the September highs in the December 30 year futures look to be the ceiling.  Prior to that, resistance can be found at 122'16.  I would prefer not to see these levels but should the S&P test 800 they will likely be a reality. 

I still like being short the 10 year note, but would prefer to have some insurance as we may be in store for an irrational spike near 121.  I like buying the December 119 calls for about $500.  They are slightly in the money, so depending on your fills and the futures price your actual cost would be a little less as you are locking in some intrinsic value.  However, they expire on Friday.  If the spike is going to occur, it will likely do so in the next few days.  Perhaps, you will be able to sell the call at a nice profit later in the week and hold on to the short futures.

Treasury Bond Option Trading Recommendations

**There is unlimited risk in naked option selling.

November 18 - I like selling the January 130 calls for 30 ticks or better, but slightly more aggressive traders may look at the129 calls for 30 (this was getting filled today). 

Treasury Bond and Note Futures Trading Recommendations

**There is unlimited risk in trading futures.

November 17 - Sell 1 December 10 Year Note futures at 118'15.

·         November 19 - Buy a December 119 or 119.5 call for temporary insurance against a spike high tomorrow!

November 4 - Sell 1 December Five year note futures at 115'16.

·         November 11 - Some of you may have acted on the suggestion to buy the 116 calls for protection, the cost was $500.  If not, don't panic...patience is a virtue.

Eurodollar Futures Trading Recommendations

**There is unlimited risk in trading futures.

Flat

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

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