November 24th, 2008

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Treasury bonds relax, but "this" may not be over.

Unfortunately I wasn't able to keep up with my newsletters last week due to, among other things, the Las Vegas Money show and extreme market conditions.  During times like this we are forced to prioritize and our clients always come first, newsletters second.  With that said, those that are following this newsletter via a free email subscription was provided with briefings.  If you are reading this from one of the various websites in which this content is posted, you may be interested in signing up for our free e-blast subscription at www.DeCarleyTrading.com to ensure more timely delivery of our comments and recommendations. 

Thursday's rally was nothing less that shocking.  I had been anticipating some sort of spike high in Treasuries due to the large numbers of net short positions being held by both big and small speculators, but I was way off the mark when it comes to the size of the spike.  In Wednesday's newsletter we pointed out the possibility for 122'16 in the long bond, and we now know that the December bond traded over 7 handles higher than our target in a single session.  I think that it is fair to say that we have just witnessed a move that none of us have ever seen before and only a handful could have possibly imagined. 

Throughout history, Treasuries have spent very little time trading at or near current levels.  The longer term prospects of such prices holding seem bleak, however, it seems as though there is potential for another round of short covering.  Imagine if you were holding short futures going into Thursday or even sold into the rally on Thursday only to get caught on the wrong side of one of the biggest bond rallies ever. 

Had you had enough money and guts to still be holding a short position in the market, you may look at today's dip as a chance to cover at horrible levels but at levels much better than seen on Thursday.  Likewise, those short January call options may be in the same predicament and will be looking to buy futures against their naked option exposure. 

A relatively soft Two Year Note auction and a swiftly higher equity market kept selling in U.S. backed Treasury futures steady.  Should stocks continue to make progress, the bond market may avoid another short covering rally as sellers pile back on at attractive prices. 

We have a healthy line up of economic data going into the Thanksgiving holiday.  Tomorrow will kick off with the preliminary GDP figures, market expectations seem to be relatively low so it shouldn't be hard to generate a positive outcome for stocks and a somewhat negative impact on bonds and notes. 

With the exception of a possible last attempt at the recent highs, we are overall bearish in Treasuries.  If you took our recommendation to sell the January 129 and 130 call options you are likely wishing that you hadn't.  However, when constructing that particular trade we were leaving room for the possibility of an irrational spike in bonds.  Accordingly, the strike prices are somewhat distant from the market despite the dramatic rally.  We are recommending that those participating in this trade sit tight for now as we do not see the March long bond trading above 129 or 130 at expiration a month from now. 

In our last newsletter, dated Wednesday November 19th, we noted that the 10 year note could see an irrational spike near 121.  The next day the note trade as high as 121'25.5.  I hope that anyone participating in the short note trades bought the protective call options as insurance.  Failure to have done so would have been painful.  Even those that did, likely let them expire to offset the entire position at a disappointing but manageable loss.  The original intent was to sell the calls and hold on to the short futures, but it would have taken nerves of steel to do so.  Our clients were recommended to leave the trade intact and accept the loss.  Adding risk didn't seem to be the right thing to do in such a challenging situation. 

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). 

·         These are both well underwater, but we haven't given up on the long-term prospects.  We recommend holding on for now. 

November 20 - We were recommending to buy the December T- note 112 puts for about 19 ticks. 

·         November 24 - You can get in at a better price, you may want to buy the 113's. 

Treasury Bond and Note Futures Trading Recommendations

**There is unlimited risk in trading futures.

Flat

Eurodollar Futures Trading Recommendations

**There is unlimited risk in trading futures.

Flat

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