I've been in a bear put diagonal (debit spread, defined risk for newer traders) since last July. TLT is a 20 year bond fund. Price moves inversely to interest rates. So this trade is based on my thesis from last summer that interest rates will rise.

It's been a very profitable trade. It requires active management. As many of you know, I use diagonals heavily and have been trading them for about 20 years.

This thread is to cover my thesis and trade and to see where others are on rate trades.

smarthelpful
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This was a smart trade, congratulations.

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I started with longs at 145, and shorts at 150. $9.20 and $0.85 for 160 days and 11 days respectively. This gives me 5 cycles of profit if nothing moved, though I'd likely find a better trade if it wasn't working in 45 days or so.

The market has moved much as my thesis, and I'm now at $112 long at 140 days and short at 108 expiring Friday. I'll roll Tusday.

I've rolled the longs down in $5 increments as the delta goes above |.64 |. As a put trade, as IV rises and interest rates rise skew becomes important as it drives IV for Deep ITM or OTM strikes.

This trade, being bearish moves very fast. Much like Peloton which I was able to ride from over 100 to 14 become it untraceable.

TLT is still very tradeable. That leads to my current thesis dilemma.

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Tuesday was a good day for this position.

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I see inflation and the Fed moving more slowly than the market does. The current math for 10 year and 20 year bonds needs inflation back at 2% or negative real interest rates still in late 2023.

I don't see that. I have inflation dropping rapidly to 5.5-6.5% by year end 2022, but getting sticky and staying above at 3+% all of 2023. I don't see the Fed dropping rates until mid next year, so a 4% short term rate till Q3 of 2023.

I also see quantitative tightening raising long term rates as the Fed stops buying bonds and starts both selling and letting bonds run off without being replaced.

This to me means the largest purchaser of bonds leaving the market. Most of the rest of the world will be spending down reserves to cover oil price inflation and so won't be buying bonds either.

If there are fewer buyers, I see prices rising, therefore an extention of rates staying higher longer.

So, my thesis is still bearish long term bonds.

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I let long term trades run, but have taken profits as this trades has gone from a 5% of my portfolio allocation up to 30% and I've now dropped it to 10%. The profit Is substantial in percentage terms, only COIN, PTON, RIOT and OXY have been better. But I never let them become as large an allocation.

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So, what are others' theses on rates? How are others trading rates, or aren't people doing it?

I trade this actively, average is still only 1.7 trades a week. I think of it as a long investment. I'm not a "day trader" either in mentality or by IRS standards, however I am an active investor using options.

My anecdotal evidence gathering is most retail traders aren't trading derivatives on fixed income. But I don't care about the average, I'm looking for people to either debate my thesis, provide their own, or give advice on improving my trade.

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TL;DR? 😅

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First off, that’s a killer trade. I had a similar on TLT in Q1 last year, but missed this one. Congratulations!

I don’t mean to be pedantic in what comes next, but to organize my own thinking - so the next few paragraphs aren’t meant to explain this to you like you’re a 4 year old.

So the key question is ‘do you stay short TLT?’ The corollary is ‘are long term interest rates going to rise or fall?’

To answer that you need to think about GDP growth, inflation, fiscal policy, monetary policy, and market psychology.

GDP growth is slowing and long term rates *typically* trade off growth expectations. That would suggest LT rates could be near the end of this cycle.

Inflation is at a generational high but shows signs of slowing down. Still, what I’ve seen from places like Hedgeye and Lynn Alden suggest that inflation rates can’t fall much faster than 2% p.a. So we could still have a 6-handle at the end of 2023. If that’s the case, rates would continue to rise. But as you said, the market (and policy makers) are talking about much faster declines.

On the fiscal side, the need for Federal issuance has fallen as ~$6T in COVID spending is expiring. The IRA injects some new money into the economy, but the Federal deficit going forward is smaller and the supply of Treasuries will fall -> downward pressure on rates.

On the monetary side, the Fed claims to be tightening and simply not buying Treasuries that aren’t issued seems to be part of the plan. So no affect on rates.

Taken together, Fed action to create negative interest rates for a couple of years helps finance COVID spending and inflation devalues the debt. I don’t think any of them want a return to 2% inflation next year…

On market psychology… almost no one in the market has traded an inflationary cycle before and certainly not an inflationary recession. The same people who believed transitory inflation last year chased a solid bear market rally this summer. I think most people in the market are conditioned to play for lower interest rates.

So net-net I think slowing growth, lower levels of Federal issuance, and the desire of most market participants puts downward pressure on long term rates. I’d take profits (like you have), keep a smaller position, and wait to add or cut based on what we see in the next couple months.

likesmart

Main thesis I have is technicals - heading towards a large support area ~100.

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Thanks MD. Interesting to pair investing and options trades like you mention above. I kind of like it

Yes, yes it was.

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VP1, you made a lot of good points. Some I've been thinking of, others I've been thinking of differently.

I suspect I'm older than most here. I bought bonds at my uncle's recommendation in 1982, and had a 12.5% mortgage back in 1986.

I thought I'd make each of your good points into a thread within this post.

Like you, some of this may sound like Im talking to a child, but as you note it helps organize thought.

With most trades, the market can go up, down or sideways. With equities or uncovered options, 2 out 3 is bad. In most verticals 2 out of the is good.

My 4 cycle cover in the diagonal is like the vertical but with leverage. If the market goes sideways and IV stays relatively flat I make just over 25% in 160 days. So, I need to be only a little bit wrong and I'm still ok.

This is one major reason I do diagonals. In the past Sharpe ratio at that would be equal to the SPY, but by Sortino would be much better as I can modify my shorts.

But being g a little wrong means there are better trades I'd miss.

GDP / GDI ISSUES.

I see GDP growth slightly up or slightly down over the next 6 months. But I track GDI (Income) more than GDP because I don't care about inventory. Over long periods they meet, but when inventory moves GDP they separate until inventory gets stabilized.

I think the supply chain had screwed up inventory badly. And GDI is up this year, but no one seems to care because they have forgotten most of Econ 220, and remember only freshman 101 and 102.

I see GDI flat, and a lot of spending out of the excess savings we've built up in last 2 years.

I have unemployment rising, but staying under 5%. That is a guess, I know, but that is still structurally close to max employment.

Partly because I think a lot of people close to retirement decided not to come back to the workforce.

This is an area I'm looking at, and I like your Real terms take. Since I use GDI in real terms and Personal income in Nominal terms I should be more consistent. GDI is the confounding one right now. It goes against most other indicators, but support job creation numbers and growth in real incomes.

Fiscal and Monetary policy.

I think we differ strongest here. Or possibly I misunderstood.

On the monetary side, I see the Fed cutting $7T from their balance sheet over 3-5 years. There is no buyer close to that level. This is also the biggest risk to my GDI thoughts as well as the GSE debt is a give part of this. Selling it means mortgage debt will be a lot higher in the future as pension and other find will find their allocations in the market without having to underwrite new mortgages.

The government is still running a deficit of about $1T, albeit much less than past 6 years. That is still net new debt.

I see this as pushing up long term rates. I think I saw you ( VP1) as seeing this differently. Do you think the Fed will allow QT? I'm seeing QT continuing and then stopping Fed Funds increases then lowering the Fed Funds. To me this means increases in the yield curve slope. This has me looking at Financials in the medium term.

On the fiscal side I don't see either party cutting spending, though I don't see any huge new initiatives. Both sides do long term planning about a week as a 13 year old with grandma's Christmas gift money.

One thing that has me hopeful is that as fast as M2 has risen velocity of money has crashed. This has led to savings and investment that is ready to be spent.

No problem with aggressive trades in an IRA, it’s a position size issue for me. Capital lost in those accounts can’t be as easily replaced due to caps on contributions so I risk manage them a bit more conservatively.

Covid money.

I totaled $6.85T in COVID USA spending approval. So far about $1T looks like it wo t be spent in various specialized allocations. Another $1T+ is still sitting in states accounts unspent, and thexrest has been spent. The states seem intent on keeping about 25% of that in rainy day Funds. The rest will be spent over 3 years or so.

I don't think many people are taking this very closely. Republicans want to claim its all spent driving inflation. Democrats want to claim its all spent hence low unemployment and great job creation.

I don't know too many finance or math masks that went into journalism so they have a hard time tracking anything more complex than football spreads.

This is the largest known unknown to me. I don't see any more major tax or spending plan changes until the next administration.

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