Sold February TLT Call Spread

I’ve been waiting for TLT to pass the $127 mark and today it reached $127.72.  I wanted the 20-year Treasury ETF to be well into the upper half of the $120s before I made this trade.  I started trading vertical call spreads on TLT more than 2 1/2 years ago and have learned to be patient and wait for the right opportunity before pulling the trigger.  I can go more than a few months without touching TLT, but when the right set-up positions itself, I try to get into it with a hedge.  This isn’t like the TLT option trades I was making a few months ago on the weeklies.  This is a planned trade with a high probability of profiting.

While TLT was trading at $127.28, I sold 10 TLT February $130 calls for $1.692 each and bought 10 TLT February $132 calls for $1.212 each.  I received $464.18 after paying $15.82 in commission for my $0.48 spread.  Based on the $2.00 spread, I’m risking $1,551.64, assuming I decide to close the position and pay the same commission again.  However, that’s not my plan.

First of all, I’m not expecting TLT to be above $130 by the February 20 option expiration.  I expect to make a profit on the option only, like I did in late 2012 and in 2013.  If TLT surprises me and continues to climb, I’ll take the assignment and go short 1,000 shares of TLT, like I did in mid-2012.  I actually want to be “forced” into an assignment with my 10 short calls.  Shorting TLT at that level opens up a huge opportunity for gains as yields revert their mean and rise again.  Rising yields means falling bond and treasury prices.  I have a strong belief that TLT will head back below $120 in 2015 and could fall below $110 if the Fed starts raising rates.

I’m not bold (read as stupid) enough to make this trade without a hedge on it.  I know it could be different this time.  Bond prices could stay elevated near historic highs for a lot longer than I think they will.  I’m fairly certain that won’t be the case, but since it’s possible, hedging is required.  When I made this trade in mid-2012, I used $127 and $129 strikes.  By expiration, TLT was trading over $130 and I took a profit on the long calls as I let the short calls be assigned (which gave me a realized gain on both legs of the trade).  I didn’t wait too long and sold covered puts (like naked puts, but with a short equity position coupled with it, the short puts aren’t naked, they are covered) to bring in extra cash and improve my gains with an exit at a higher price.  Had I not hedged back then, my breakeven point would’ve been lower (i.e. farther away) as TLT started to fall.

This time, if my short calls are assigned, I’d like to try to stay short longer and make more from the falling price of the ETF.  It’s a great plan, but once you have $130,000 short on an ETF, plans don’t feel as easy to stick to.  Also, being short TLT means that I have to pay the dividend each month and it helps if I sell covered puts to cover the cost of being short.

In December 2012, when I closed my TLT vertical spread for a profit, I noted in my trader’s journal that I should’ve used lower strikes to bring in higher net premiums.  I’m not listening to my own advice because I decided this return is good enough as it is and gaining the extra $3 in room for error is worth the difference.  I didn’t expect this trade to hit today.  The bid/ask for the spread was $0.30/$0.60 when I placed my limit order.  Within 30 minutes I lowered my order to $0.48 because I thought it would take a big move at tomorrow’s open to make it hit.  Instead, I found a buyer within another 20-30 minutes.  Now the nine-week wait begins before I know my next step.  That is, if TLT doesn’t tank before then, which would allow me an early exit with the vast majority of my profit in hand.

TLT Vertical Call Spread Risk/Reward Breakdown

• Potential profit: $464.18
• Potential return: 30.22%, Not worth annualizing since I can’t make this trade often
• Breakeven price: $130.47
• Upside protection: 2.45%
• Money at risk: $1,551.64
• Recent high: $127.72, hit late this afternoon