How Options Expiration Could Impact the Beaten-Down ETF

The 10-year bond fund is trading below a number of expiring call-heavy November strikes

Editor-in-Chief
Nov 13, 2018 at 9:49 AM
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Spiking bond yields were one of the major factors that rattled equity investors in October, and accordingly, the iShares 20+ Year Treasury Bond ETF (TLT) took quite the proverbial trip to the woodshed. On Oct. 3, the fund broke below previously stalwart support in the $116-$116.50 area, which had supported lows in February, May, and September. TLT's subsequent rebound attempt was unceremoniously halted near the $115 level -- home to its descending 30-day moving average and a 10% correction from its Dec. 15, 2017 intraday high -- and by Nov. 2, the 10-year bond tracker slumped to its lowest intraday level (at $111.90) since July 2014.

This bruising sell-off in TLT was accompanied, unsurprisingly, by heavy outflows. Data from etf.com shows net outflows in excess of $1.69 billion for the period from Oct. 1 through Nov. 8, representing a decent-sized chunk of the exchange-traded fund's (ETF's) $7.68 billion in assets under management (AUM). And with sinking bond prices in the hot seat, TLT garnered its highest monthly trading volume since September 2011, with 262.92 million shares exchanged.

However, it seems speculative players are betting on TLT to bounce back from multi-year lows. TLT call open interest had crested, as of Friday morning, to 828,464 contracts -- the highest since May 18, and a reading that registered in the 99th percentile of its annual range. Notably, the fund's reigning call open interest peak occurred just one session after TLT had set a new 52-week low of $116.09 on May 17, so TLT call traders seem to have a penchant for "buying low" (so to speak).

Further cementing this trend, combined data from the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) shows TLT with a 10-day call/put volume ratio of 1.32, as the number of bullish bets bought to open have outnumbered bearish in recent weeks. This ratio arrives in the 84th annual percentile, confirming a stronger-than-usual slant toward TLT calls over puts.

And despite the multiple layers of technical resistance that now lie overhead for TLT -- along with the 30-day trendline, note the 50-day and 200-day moving averages on the accompanying chart -- it's hard to fault call buyers for rolling the dice on an oversold bounce, given how low premiums are running on the bullish side. Currently, Trade-Alert pegs 30-day at-the-money implied volatility (IV) on TLT at 9.0%, which arrives on the south side of this metric's 52-week range between 8.0% and 15.8%.

However, in spite of the recent skew toward call buying, put premiums have rarely been steeper. TLT's 30-day IV skew stands at 16.2%, in the 97th annual percentile, which means puts have priced in higher volatility premiums relative to their call counterparts only 3% of the time in the past year. So while the combination of rampant call speculation on a technically weak underlying instrument might be appealing to contrarian bears, the entry costs on short-term TLT put trades may be off-putting for some prospective traders at the moment.

As we head into November options expiration week, bond-watchers should be aware that calls don't start to outnumber puts in a meaningful way until the TLT 115 strike and higher. If the price action in this ETF remains uninspiring, the unwinding of hedges related to those out-of-the-money calls could provide fresh expiration-week headwinds -- but a TLT rally could cause these call-heavy strikes to act like "magnets," potentially sparking a major mid-month rebound.

tlt daily chart 1109

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, November 11.

 

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