The TLT ratio spread that I opened yesterday helped cut my losses today, but I still wasn’t fully hedged yet on my TLT exposure, so I came back to the well to cut my risk again. While TLT was trading at $133.66, I sold 10 TLT June $125 calls and bought 20 TLT June $134 calls for a net premium intake of $229.19 after paying $22.81 in commission. My limit order was for $0.25 per spread and eight of the orders traded for $0.25, while two earned $0.26. Although I placed the order together, I sold the $125 calls for $9.95 to $10.09 and bought the $134 calls for $4.85 to $4.92 in nine separate transactions within two seconds.
I decided to go ahead and hedge all of my TLT exposure out of the fear that rates would keep falling (bond prices move inversely to interest rates). I believe interest rates will reverse before TLT breaks above its January 30, 2015 intraday high of $138.50, but if I’m wrong, I could be in a bad place. If TLT does make it back into the upper $130s, I’m now in a position to dump 10 of my long calls for a profit without running the risk of a margin call.
If rates start to rise, I’ll lose on my long calls as TLT retreats, but will gain on all of my short calls for a net profit from where we are today. Nobody can accurately say where rates and TLT will be in a week and much less a few months, but we can all agree that it’s extremely unlikely TLT will remain flat for the next few days, weeks, and months. Because of TLT’s volatility, I increased my probability of exiting this series of trades with a profit by buying the ratio spread two days ago with a May expiration and today’s trade with a June expiration.
Ideally, TLT will fall below my lowest short TLT call at $124 by June expiration and I’ll walk away with a huge profit from everything I’ve bought and sold on top of the covered puts I’ll start selling next week before my 10 February calls are assigned. TLT has been paying a dividend around $0.25 on average for the past few months. I’ll be responsible for paying out that dividend while I’m short the shares. This expense will factor into what strikes I sell on the covered puts because I’ll need to bring in at least as much as I’m paying out and preferably a decent amount more.
If TLT does not retreat like it has on every spike in the past, I’ll simply continue to push my hedges out on the calendar and will add new ratio spreads on TLT as long as I need to. The biggest risk is if TLT finishes May and June just below my long call strikes. I’ll have the losses on the short calls, but no gains on the long calls. Again, the risk is extremely slim of TLT being exactly where it is today in three and four months. The volatility will work to my advantage. Some months I might be able to able to sell new calls at a higher strike which will create a better opportunity to profit when TLT does eventually collapse. If TLT falls some, but not below my short strikes, I’ll be able to buy lower strike hedges to make it easier to profit later if/when TLT spikes again.
If nothing else, being hedged will make it a lot easier to watch the daily price advances much easier to stomach.