May 28th, 2009

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Treasuries stabilize...kind of

It has been a grueling couple of days for bond traders as volatility has been high and certainty low.  Treasuries have been under swift selling pressure in the face of record breaking government auctions and rumors of decreased foreign demand and a revision of the Fed's AAA credit rating.  However, as of Thursday's close, there seemed to be a little less panic and hopefully less volatility going into next week.

All in all, the day's economic news was slightly bearish.  On the jobs front, initial claims for unemployment benefits was reported to be 623,000 down from 636,000 in the previous month.  Similarly, durable goods orders were reported to be better than expected at an increase of 1.9%.  On the other side of the argument, new home sales were slightly weaker than expected. 

The real story of the day was the 7-year note auction which attracted the attention of both equity and interest rate traders.  As it turns out, the auction was met with solid demand just as the 5-year and 2-year notes were.  Bonds and notes crept higher in post auction trade but the catalyst for afternoon buying seemed to be Pimco analyst Bill Gross.  Mr. Gross' interview on CNBC lured buyers back to Treasuries after he mentioned that yields were beginning to look attractive.  As a broker that had previously advised clients to sell puts, I am wondering why Bill couldn't have mentioned this yesterday...a memo maybe?

If you have been following our short put recommendation in the 30-year bond, we came into the session in a defensive mode.  While there was still a considerable amount of room  between the futures market and our strike prices of 112 and 109, we deemed the position to be a little too close for comfort in a fast moving Treasury market.  Accordingly, we recommended that clients holding both the 112's and 109's sell the 123 calls for 30 ticks this morning.  Later in the day, we opted to use the premium collected to cover part of the cost of a July 110 put.  The net result is a trade with a dramatically lower delta and less risk assuming that the market doesn't completely melt down.  While I still believe that both the 112 and the 109 puts will be profitable at some point before or at expiration, we felt that it isn't wise to ignore the potential risks of a runaway market.  I live in Vegas, but I prefer not to roll the dice when it comes to trading.  If it appears that things have begun to stabilize we will look to sell the long puts and hold the strangle in hopes of declining volatility.   If these types of adjustments or futures option spreads and/or outright option trading interests you, you may enjoy my book "Commodity Options".  It is available in all major book outlets. 

* Due to time constraints and our fiduciary duty to put clients first, the charts provided in this newsletter may not reflect the current session data.  However, market analysis and commentary does.

Treasury Bond and Note Option Trading Recommendations

**There is unlimited risk in naked option selling.

May 21 - Our clients were recommended to sell the July bond 112 puts for 25, fills ranged from 25 to 23.  This option traded at just 10 ticks early in the day but an explosion in volatility allowed us to sell the option for a considerate amount of premium.  The premise of the trade is to profit from declining volatility and or positive bond movement.  The strike price is over 7 handles out of the money to give the position a considerable amount of room for error but of course the risk is unlimited below 112. 

May 27 - We recommended that our clients sell the July bond 109 puts for 25 or better, some fills were reported near 30. 

May 28 - For those holding both the 112's and the 109's we lowered the delta of the trade by selling the July 123 calls for 30 and buying the 110 puts for 56.  If we detect stability, we will salvage what we can for the long put and hold the strangle. 

Treasury Bond and Note Futures Trading Recommendations

**There is unlimited risk in trading futures.

May 26 - Buy the June 5-year note at 116'05 or better 

Eurodollar Futures Trading Recommendations

**There is unlimited risk in trading futures.

Flat

*Due to the volatile nature of the futures markets some information and charts in this report may not be timely.

There is substantial risk of loss in trading futures and options.