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How to Play a Retreat in Treasury Bond

Matt Zeman offers an options play to take advantage of a drop in volatility and a retreat in the 30-year Treasury bond.
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In mid-day trading action on Tuesday we are seeing most markets sharply lower. In my opinion, this is due to not only investor angst over the Goldman Sachs hearings today, but also the credit ratings of Greece and Portugal being downgraded by Standard and Poor's.

It seems to me that investors are becoming more and more fearful of defaults by European nations. This appears to be causing investors to shed risk today. Because of this, I am seeing bonds and notes sharply higher as well as the greenback.

The 30-year Treasury bond is trading near the top of its recent trading range. In my opinion, I think we could see it retreat in coming sessions. I feel there is too much supply in the marketplace right now, and that the


is getting closer to tightening credit.

The market in my view has done an excellent job in recent months of sweeping bad news under the rug so to speak. Time will tell if this proves to be the case following today's news. I do feel we could see things calm down a bit in the coming sessions. Here is a way to try to take advantage of a drop in volatility and a retreat in bond prices should it occur.

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Sell the June Treasury bond 120 call option for a premium of $468.75 or better. Assuming commissions and fees of $50 per contract, this would leave the investor with a net premium collected of $$418.75. This position profits if at expiration the June futures contract is at or below the strike price plus the premium collected.

In this case, that means that at expiration the position breaks even if the June bond futures contract is at 118'26. , and it profits if the contract is below that price. The risk on this position is unlimited. An investor can lose if the June futures contract is above the breakeven of 118'26 at or any time prior to expiration.

This is a marginable position, and therefore an investor can also lose money if the market makes an adverse move prior to expiration generating a margin call and the investor is forced to close the position. The position value can fluctuate very rapidly and at times experience wild swings and therfore an investor may also close the position with a loss prior to expiration without a margin call.

An investor must determine his or her own tolerance for risk on a position. In terms of Treasury bond futures, the investor will lose $15.625 per every point that the price is over 118'26. The risk of loss is substantial. Selling of options is not suitable for all investors. An investor can lose more than the original investment.

Buy a June 116 put option for a premium of $375 or better. This position can potentially profit if bond prices fall below the strike price of 116 at or before expiration. The maximum risk when purchasing an option is the premium paid-in this case the investor cannot lose more than the $375 paid plus $50 in commissions and fees for a total loss of $425.00 I recommend holding this position for no longer than seven to 10 days.

Matt Zeman is a principal with Lasalle Futures Group and chief market strategist for Time Means Money.Com.