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November 15, 2011

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Overnight Treasury futures gains erased

Higher European yields and lower global equity markets promoted safety buying in U.S. Treasury futures during overnight trade.  However, the bulls ran out of gas as the day progressed amidst good economic data and a recovery in the Euro currency. 

Inflation at the producer level was reported to be tamer than expected while retail sales was better than expected.  This combination in itself had little impact on trade simply because the implications of each canceled each other out.  Nonetheless, a dramatic improvement in the Empire Manufacturing index and an optimistic reading in business inventories tilted the scale to the bears. 

We are growing a bit tired of directionless trade, as I'm sure many are.  Without clear cut conviction in either direction, we are faced with a market that is difficult to write about but even more difficult to trade.  We've had many ask about the possibility of selling strangles in Treasuries; this is a trade that could easily work out but if it doesn't has the potential to be extremely painful.  Should volatility come back to the markets, the comfort of being delta neutral won't last for long. 

From yesterday's newsletter but still valid:

The year-end holidays, particularly Thanksgiving, have a history of being a volatile time of year for Treasury futures.  I'll never forget the massive bond rally that took place in 2008; it began just before Thanksgiving break and lasted well into December only to peak just before Christmas.  For those that are new to Treasury futures, you might be surprised to hear the aforementioned run moved prices in the 30-year bond from about 113 in early November to 143 by mid-December.  Of course, this magnificent move took place with a potential banking system collapse as the back drop.  We certainly don't expect a repeat of 2009, but it is worthwhile to use this as a reminder as to the chaos light volume holiday trade can cause. 

As we have been noting in this newsletter, the seasonal tendency through much of November is bullish.  Although this year hasn't been a picture perfect image of what has historically been the case, we still have a few weeks of potentially strong Treasury prices.  That said, the tides often turn just after the Thanksgiving holiday and give way to light volume selling that often seems relentless and unfounded. 

Where are we going with this?  We feel as though position traders will soon be given the opportunity to play the downside from better prices.  With that in mind, we realize it is very difficult to be patient and recognize the fact that we could very well be wrong about a short-term rally before rolling over (AKA missing the trade).  For those of you that can't stand the thought of missing out on the possible down-draft and "have" to have something on...perhaps put spreads make sense such as the January 10-year note 129/127 put spread.  The total cost is about $600, and this is also the total risk.  This position could pay off as much as $1,400 if the futures price is below 127 at expiration 40 days from now.  If you are looking for a massive drop, you might be best off with lottery tickets such as the January note 126 puts for cost and risk of about $312.50 before transaction costs. 

We will be looking for a place to implement a short 5-year note futures with the protection of a long  call option in the coming days. 

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

Treasury Bond and Note Option and Futures Trading Recommendations

**There is unlimited risk in naked option selling.

Flat 

In other commodity markets....

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*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.

Past performance is not indicative of future results.  The information and data in this report were obtained from sources considered reliable.  Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities.  Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.