In the past I had always put the cash in my trading account into treasuries (in the form of TLT) as a zero risk position. With the future of treasuries coming more and more into doubt I am looking to hedge even my treasuries position. The way to hedge treasuries would seem to be to buy TBT in .5 dollar amounts. The problem, of course, is that TBT pays no interest so that my interest on the net would be reduced by 33%. That means that instead of getting 3.95% I would only be getting only 2.6%. Question #1: I can sell calls on TBT to get my return back to a nominal 3.95%. Right now with TBT at 47.08 I can sell the Jan 2011 60 call for 1.43 giving me an annualized 3.75% on the TBT. The combined trade: TLT + TBT + short 60 call would yield me 3.88%. Anything wrong with this other than the 60 limit on TBT?? Question #2: TLT is currently selling for 91.22 and is returning 3.95%. The Jan 2011 90 put is bid at 6.20 yielding 7.4% compared with 3.95% for the stock...and I get my money up front. Anything wrong with substituting the short 90 put for the long TLT in the above set up giving : Short jan 2011 TLT 90 put + Long TBT + short TBT Jan 2011 60 call??? What can happen? I don't have a good way of modeling the whole thing together. Thanx for thinking about it.
There are two places you can get into trouble that I see. First, TBT does not exactly mirror .5 TLT short. Second, the spread on the options will eat into the tiny interest advantage you are trying to gain.
1) TLT is not "zero risk". If long-term interest rates go up, you'll suffer. 2) TBT may not "inverse correlate" well to TLT. 3) Question-1?.....Sell an at-the-money call if you're bearish in order to maximize your premium earned. Ignore capital gains. Your "net position" would approximately be the short-call. You're not "flat". 4) Question-2?......there's something "weird" about the put premium. It seems larger than it should be. It may reflect an impending distribution from the ETF. TLT may be hard-to-borrow. I don't know for sure. Your "net position" seems "flatter". The TLT-put offsets the TBT-covered-call, which is synthetically an inverse-short-put....?.....(brain overload).......Martinghoul, Nitro, xflat2186, Atticus, please help out here.
Combining TBT and TLT in a 1:2 pair would give you a result far different than the correlation that you expect. Leveraged ETFs have compounding errors and over time their values skew away from the underlying that they track. There are cumulative time periods where TBT far out/under performs TLT by far, far more/less than 2:1 Adding options to the equation complicates it even further since assignment on one side or lack of assignment on the other can leave you in an unbalanced position (the pair ratio hedge is gone). The large put dividend implies that there is a dividend lurking. Check to see if there's a large annual dividend. Concluding that any combination of these is risk free is a flawed conclusion.
This graph demonstrates that TBT and TLT are NOT mirror images over longer terms: http://ichart.finance.yahoo.com/z?s=TBT&t=2y&q=l&l=off&z=m&c=TLT&a=v&p=s While for shorter terms the correlation is much better: http://ichart.finance.yahoo.com/z?s=TBT&t=3m&q=l&l=off&z=m&c=TLT&a=v&p=s Obviously something less than 3 months is desired Like a few days: http://ichart.finance.yahoo.com/z?s=TBT&t=5d&q=l&l=off&z=m&c=TLT&a=v&p=s