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Tales of a Technician: Bond. Treasury Bond.

November 18, 2015

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Tales of a Technician: Bond. Treasury Bond.

Last week we learned about the relationship between bond prices and interest rates. Specifically, why they sit on opposite ends of a teeter-totter and why Janet Yellen might be a dunderhead (j/k Janet. Luv u). This week, I’ll share how you can keep your pulse on all things fixed income (the big boy word for bonds) and interest rates. Also, perhaps, more importantly, I’ll give a look at how you can score some cold, hard cash if you believe the long-awaited and much talked about rising rate regime is finally beginning.

Though the bond market is a broad umbrella enveloping a number of trade-able products, let’s focus on Treasury bonds. As the name implies, these are bonds issued by the U.S. Treasury to fund help the profligate spending of the government. Due to their popularity, Treasuries are followed closely by the financial media and traders across the globe.

Pro Tip: The Treasury market is full of jargon. Here are three common terms along with their definitions so you can play along at home. Treasury Bills (T-bills) are basically government debt securities with a maturity of less than one year. Treasury Notes (T-notes) are government debt securities with a maturity between one and 10 years. Finally, Treasury Bonds (T-bonds) are government debt securities with a maturity of more than 10 years.

Thanks to the advent of exchange-traded funds, it’s incredibly easy for retail traders to track and trade bonds. While there are a number of ETFs to choose from, consider limiting your selection to the most liquid; especially if you want to trade options. Allow me to introduce you to the iShares Barclays 20+ Yr Treas. Bond ETF. Heck of a name, I know. It trades under the ticker symbol TLT and it’s the outright king of the hill in the world of bond trading. I wouldn’t touch options on any other bond ETF. You can trade stock all day long on them, but not options. Most others boast the liquidity of the Sahara.

On second thought, the liquidity for TBT options isn’t bad, either, but it’s an inverse leveraged ETF. Caveat emptor.

What makes TLT particularly attractive to trade is its elevated sensitivity to interest rates. A change in rates affects long-term bonds much more than short-term bonds. This heightened sensitivity generates much more volatility in TLT, making it a more exciting underlying security to trade in a world as drab and boring as bonds. To get an idea of how a 1% rise or fall in interest rates effects Treasuries of varying maturities consider the following graphic from a recent JPMorgan Asset Management report:

Rates

As shown in the red box, a 1% rise in interest rates only delivers a 2% loss to 2 year Treasuries (2y UST), but a whopping 16.9% loss to 30 year Treasuries (30y UST). Perhaps now you can understand the panic attack suffered by long-term bondholders every time the Fed hints at a rate hike. Of course, they could always shorten the duration of their holdings to reduce interest rate risk, but that’s a story for another day.

So TLT is your go-to ETF for bond bets. Remember that cold, hard cash I mentioned earlier? Yeah; that’ll arrive on your doorstep courtesy of bearish plays on TLT if interest rates do indeed ascend in the months to come. If you want to track short-term or intermediate-term Treasuries, I suggest SHY or IEF. Be forewarned: they’re both boring to trade and are best used simply as a reference.

Next, we turn to bond yields. The one that gets the most attention is the 10-year yield. You can chart this with the ticker TNX. Right now, the 10-year yield is at a lowly 2.2%. That’s right. Do you want to lend some dough to Uncle Sam for ten years? Have at it! But all you get in return is a paltry 2.2% annual interest payment. Welcome to the world of ZIRP – that’s zero interest rate policy for you newcomers.

In case you were wondering, you can track 30-year yields with TYX. Yes, the chart of bond yields is the inverse of the corresponding bond price. So TYX and TLT are opposites as are TNX and IEF. I’m thinking next time I may delve into the yield curve (or perhaps I’ll save that for the newsletter so I can really rattle on about its power).

For those otherwise tiring of all the discourses on debt, cheer up. Another tantalizing topic is comin’ round the corner.


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