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In this article I wrote about an example trade to take advantage of a potential decline in t-bond prices.  So far so, er, well, bad for t-bonds but good for the example trade.  See Figure 1 (for sake of example this trade is based on a 7-lot which risks $973 instead of a 1-lot that risks $139).Figure 1 – TLT Apr 120-115 bear put spread (Courtesy www.OptionsAnalysis.com)Figure 2 – Equity curves for TLT Apr 120-115 bear put spread ; Risk of loss remains (Courtesy www.OptionsAnalysis.com)

The good news is that this trade has generated a profit of 76% in just 7 trading days and there is a great deal of additional profit potential (roughly $1,800) if t-bonds do in fact decline to the target price level of $112.78.

(See also It’s Hard With ‘Oil’ These Choices)

The bad news is that t-bonds neared a support level and rallied intraday (suggesting that the decline may stall, at least for a while).  The other bad news is that this trade could still turn into a 100% loss of premium if t-bonds were to rally from here.

What to Do, What to Do?

The simplest choice is to do nothing and let it ride. But in reality, it comes down to one’s priorities.  To wit:

*If you really think that bonds will continue to sell off then “letting it ride” makes sense at this example trade offers good additional profit potential.

*On the other hand, if you wish to “let it ride” while also “reducing or eliminating the risk of loss” then an adjustment may be in order.

So for example’s sake, one (of many possible) adjustment is shown in Figures 3 and 4.  This example involves a strategy known as “rolling down”.

*Sell 7 TLT Apr 120 puts

*Buy 7 TLT Apr 115 puts

*Buy 4 TLT Apr 117 puts

*Sell 4 TLT Apr 112 puts

The particulars for this adjusted position appear in Figures 3 and 4.Figure 3 – TLT adjusted bear put spread (Courtesy www.OptionsAnalysis.com)Figure 4 – TLT adjusted bear put spread risk curves (Courtesy www.OptionsAnalysis.com)

(See also With Retailers, it’s ‘When’ Not ‘What’)

Things to note:

*The worst case scenario for this new position is a profit of $210 (versus a risk of loss of -$973 for the original position).

*The maximum profit potential falls from $2,527 to $2,210.

So in a nutshell:

Figure 5 – Reward-to-Risk Tradeoffs from current levels

Summary

The purpose of this article and the original one in the link above is not to advise you and tell you what to do in t-bonds.  The purpose is simply to educate you regarding the many ways possible to trade various markets without risking large sums of money – as well as how to adjust a position to look in a profit and/or to  improve the reward-to-risk tradeoff.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.