On July 12, 2018, U.S. Commerce Secretary Wilbur Ross said he would be selling all of his equity holdings and buying Treasury securities with the proceeds.
This trader found this disclosure extremely interesting. Does the tone from the top signal an impending market collapse? I’m not sure about that, but I am sure I can give you a trade idea to mimic what those who could be in the know are doing.
The first thing to do for this setup is to be short equities, meaning a setup to profit if the market goes down in price. An easy and low capital way to do this is to buy a put spread in SPDR S&P 500 ETF (SPY). It has an implied volatility rank of 12 right now, meaning the prices of the options are only at 12% of their highest over the last year; this is not an ideal time to sell option premium. By buying the 280 put and selling the 279 put in the September options cycle, it would cost $37, which is the total risk in the trade. The breakeven is slightly above the current price of $279.37 at $279.63. This type of trade, being short, the market goes against conventional wisdom. However, if you believe in the buy low, sell high principle and think that Mr. Ross could be Mr. Right, this is one way of getting short the market.
Now we have to get long bonds. In this way, we are not going to care about how the 2-10 year yield spread in the treasuries has collapsed to 25 basis points, the lowest in 11 years. Taking advantage of the yields on the bonds is not the goal, rather it is positioning for the price of the bond to rise. Think of it this way, a stock like Coca-Cola Co. (NYSE: KO) pays a dividend to its shareholders when it turns a profit. But the price of Coke, not just in bottles but also on Wall Street, can vary from day to day. The same is true with bonds. My assumption is that he believes the prices of bonds will be going up faster, or in inverse to, the equity market.
To get long bonds, we could put on the opposite trade to the SPY trade above. Looking at iShares 20+ Year Treasury Bond ETF (Nasdaq: TLT), we can see that the options prices have an implied volatility rank of one. One, seriously, this is a rare occasion. What you see today, July 13, 2018, could be the lowest day of the year in the price of the TLT options, talk about bonds on clearance! Going into the September cycle, we could buy a 121 call and sell a 122 call against it. By doing this we are going to pay $57 to enter the trade, which is our max risk, and the max profit is $43. Now I know you’re thinking, who cares about $43 in profits? Let’s rephrase and say, who doesn’t care about a 75.4% return on capital? Now I’ve got your attention right? The breakeven on the trade is below the current price of $122.41 at $121.57.
Either of these trades could be modified by widening the distance between the strikes, doing so will increase the dollar amount of potential profit and potential risk. Because we are doing a cross product pairs trade, it’s hard to say what the whole probability of profit is on these two when combined but individually they are each greater than 50%. There are 70 days until these options expire and with the kind of insight and pull that the U.S. Commerce Secretary has, it may not be too bad of an idea to follow his example.