Here’s How To Generate 425% Returns On Higher Interest Rates

| March 21, 2018 | 0 Comments

percentagesThis week, we get the next installment of the FOMC meeting – the big Fed meeting where they decide what to do with interest rates.  The meetings are a bit more interesting these days since rates are going up and some sort of definitive actions tends to take place.

Keep in mind, we had several years where the only thing investors were concerned about is what the Fed was doing with QE (Quantitative Easing).  Interest rates weren’t even in the picture at that point.  These days, we’re back to some level of normalcy, with rates slowly heading higher.

The market is expecting the Fed to raise rates by a quarter point.  According to the CME’s Fed Fund Futures, there’s about a 90% probability of it happening. That part isn’t really what investors will be focused on.

Instead, it’s what the Fed says about the economy and inflation that will really be the primary focus of the market.  Of course, inflation concerns are a big part of why we had the early February selloff.  It’s not entirely out the question that the Fed says something which will subsequently send stocks much lower (or much higher).

What the central bank sees in the economic data, especially in regard to inflation statistics, should go a long way towards defining their rate increase strategy this year.  In other words, it could very much be an important FOMC meeting.  It could also be a complete snooze fest.

Regardless, plenty of traders will be positioning themselves in various assets in preparation of the announcement.  One popular instrument for trading the Fed meeting is iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT).  Bond prices are based almost entirely off of interest rates and interest rate expectations, so action in TLT makes sense ahead of the FOMC meeting.

While a quarter point increase is already built in to the market, further increases may or may not be accounted for.  If investors believe interest rates could go higher faster than originally anticipated, bond prices could take a dive.

At least one trader in TLT is betting on treasury bonds having pretty decent downside potential over the next month.

iShares 20+ Year Treasury Bond ETF

Here’s the trade…

With TLT at $120, the April 20th 115-118 put spread (buying the 118 put, selling the 115 put) traded for $0.48.  The vertical spread, as this sort of trade is called, was executed 500 times.  That means the max loss is just the premium paid, or $24,000, if TLT remains above $118 over the next month or so.

Breakeven for the trade is $117.52 and max gain is at $115 or below by April expiration.  Max gain is $126,000, so the trader has the potential to generate 425% returns on the trade.

This is exactly the type of trade I’m a big fan of.  It has minimal risk with very strong return potential.  It’s the kind of trade I frequently make in my options trading service. The timing suggests it’s related to expectations of higher interest rates post-FOMC meeting, which makes perfect sense.  In fact, there’s nothing wrong with doing an exact copy of this trade in your own trading account.

 

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Category: Options Trading Strategy

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Jay Soloff is an options analyst with Investors Alley.

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