It Is Hard to Justify Lofty Prices in Treasuries. Something Isn't Right.

09/07/2017 2:59 am EST

Focus: FUTURES

Carley Garner

Senior Strategist and Broker, DeCarley Trading, LLC

Trade idea: we like selling the December T-note future and then selling a 127 put (at-the-money).  This creates a trade with a profit potential of roughly $1,000 before transaction costs and a risk buffer up to 128,  asserts Carley Garner, Senior Strategist for DeCarley Trading.


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Something doesn't feel right in the Treasury market.  Economic news has been positive, stocks have been roaring, bonds and notes are lofty in respect to technical analysis, and the Fed is in the midst of a rate hike campaign.  Aside from bullish seasonals, it is hard to come up with a good reason to be bullish the longer-end of the Treasury curve (5-year notes and above). 

Also, you've likely been hearing about the flattening yield curve. Yields on longer dated maturities have dropped this year while the yields on shorter maturities have gone up. 

Theory suggests that a flat yield curve is suggesting a sluggish economy going forward because a flattened curve hinders bank profits and their willingness to lend. Also, it is a sign the markets are expecting little growth.  After all, if they were expecting robust growth they would expect more premium for holding longer-dated maturities.
There are two sides to the story.  Many believe this time is different because the lower rates are the result of manipulative central bank policy, rather than natural market rates.  Accordingly, the short end of the curve has slightly normalized while the long end simply hasn’t (yet). 

In any case, there are some odd things brewing in Treasuries and we have a feeling the 10-year note and 30-year bond are getting toppy.  To normalize the curve, either the short-end needs to see lower yields or the long-end needs higher rates.  We are leaning toward the latter. 

We have been patiently waiting for Treasuries to meet our upside targets before taking action with bearish trades. Unfortunately, the moves have occurred in overnight or early trade leaving little room to get off short call option strategies.  Instead,  we like the idea of covered puts using the December futures and options. 

chart

Specifically, we like selling the December T-note future and then selling a 127 put (at-the-money).  This creates a trade with a profit potential of roughly $1,000 before transaction costs and a risk buffer up to 128.  Our charts are suggesting any rallies, although unlikely, should be capped near 127'18. If the futures market moves above 128, our position will essentially be a naked futures contract (with theoretically unlimited risk).

Seasonals are bearish for the next few weeks, but then turn bullish so be prepared to take a quick profit if it presents itself. 

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