How to Short Bonds With Options (Live Example)

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Shorting bonds: In tonight's video, we're going to go over all the trades that we had for Friday, November 6. There was just one, single trade we had today on Friday, and that's a new opening trade in TLT. Not an earnings trade actually, just a regular bearish trade that we're making in bonds.

The reason is that jobs numbers came out, the market took it okay, but bonds took it on the chin today. We saw bonds trading down much, much worse than they have in the past, actually gaping lower. I think that trend may continue as maybe the talk of a Fed rake hike might start to come to fruition in December, or sometime around there.

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shorting bonds

We're just going to play bonds to the downside a little bit. I like this play. The probability of profit isn't showing up right now. It should by the time you guys watch this video. It's about a 50% probability of profit. As always with these debits spreads, they are much more directional in nature.

The reason that we did the debit spread is that implied volatility rank is in the 19th percentile. With IV that low, and here's a look at where TLT is trading today. With IV that low, and the stock heading lower, we can't do anything except for really a calendar spread or a debit spread.

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We already have a couple of calendar spreads, so we don't need any new calendar spreads. We've got some exposure to calendar spreads. We want to play this a little more directional. It's a true kind of directional trade, basically a 50-50 bet. Not necessarily a high probability trade. I think the likelihood of bonds heading down in the next month or so is pretty good, at least at some point in the future.

Again, what we did with this trade is that the stock closed at about 119. We bought the 120 puts, and then we sold the 118 puts, and that gave us a net debit of $1. It moved our break even point to about 119. With the stock trading at 119, our break even point at 119, you can see why this is a 50-50 bet.

Very small allocation, as always with these debit spread trades, we're doing it very small, even though we did three contracts. For our portfolio size, this is extremely small. Just make sure that you're adjusting your positions accordingly to your portfolio size.

Again, all we're trying to do here is take advantage of maybe a little bit of a down move here in TLT over the next month and a half. You can see where we put our strikes, so stock closed today at 119. We bought the 120s, sold the 118s. That gave us an effective break-even price right about 118, I'm sorry, 119.

We have a pretty good chance that at some point it's going to trade below there. When it does, we'll have an opportunity to close these things out at a profit. Remember, with debit spreads; we're trying to close this thing out at 25% gain of max credit, of the debit that we received. We're trying to look to buy this thing back for each contract for about a $1.25, $1.30.

That's where you want to place your automatic closing order because we want to get that much out of these contracts. We're not trying to get the full $1 out of them all the way at expiration. We're going to close them out early. If we have a profit, take money off the table, and bank ourselves hopefully a winning trade.

As always, I hope you guys enjoy these videos. If you have any questions at all, please ask them right below in the comments section. Until next time, Happy Trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.