Warren Buffett once said that the gravitational pull to asset prices is interest rates. If the options market is right, things could get serious.
Case in point: TLT, iShares 20+ Years Government Bond ETFI am trying to track the performance of an index of US government bonds. A quick look at the fund’s holdings shows that the shortest maturity date is nearly 20 years away, in February 2046, and the longest maturity date is almost 30 years away, in August 2056.
Most investors consider U.S. Treasuries to be the safest investment in the world, and have heard people say that the U.S. can never (or should not) default on its debts because they are repaid in U.S. dollars and governments can and do create them out of thin air.
To the extent that some say there is no real credit risk (the risk that the borrower will not be able to repay the loan), I agree. But credit risk is not the only risk that bond investors face. There is also interest rate risk. When interest rates rise, bond prices fall. A bond’s sensitivity to changes in interest rates is a function of the bond’s maturity. All else being equal, the longer the maturity, the more sensitive it is to changes in interest rates.
TLTFrom the beginning of the year to today
This was a lesson long-term bond investors learned very painfully in 2020 when long-term interest rates started rising. TLT fell by approximately 52% from the second half of 2020 to the second half of 2023. The total return after interest was slightly better due to the coupon payments, but only slightly because the coupons were so low. since then, 30 year US Treasury rate Until the past few weeks, when it decisively surpassed the 2023 high, it was mostly range-bound between the Q4 2023 high and low. It rose another 7.6 bps today, and options traders are taking note. TLT traded about 1.6 million option contracts on Thursday, nearly double the average daily volume, and 856,750 put contracts, about 3.3 times the average volume.
The most active contract was the October ’79 put, with 123,649 contracts traded at an average price of $0.4786 per contract. One of the largest trades was October’s 80/79 put spread, with 65,000 contracts traded at a net withdrawal of $0.275 per spread. This was a nearly $1.8 million bet that TLT, which closed at $80.78 after hitting a 52-week intraday low of 80.665, would fall below the $80 put exercise by at least the premium paid. Traders betting on TLT falling are betting that long-term interest rates will rise, hurting housing trades and other industries that need to borrow long-term funds at ever-higher interest rates, the biggest driver of which is the U.S. government itself.
Regardless of whether you believe rates will stabilize, note that this is a more profitable bet than 2.6:1 if TLT falls below $79 by the October deadline. This is a decline of $1.78 in 35 days. If you think moving long-term Treasuries is too much work, consider this. This is the range of fluctuation between Tuesday morning’s high and Thursday afternoon’s low.
Disclosure: Tidal owns/holds all securities mentioned in the article.
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