May 30, 2007
Buy December Treasury Bonds
Buy 2 December 111 calls and 1 December 109 put, costing about 4 points, or $4000.
From a statistical standpoint, the recommendation made here would have "worked" for every one of the past 25 years.
By "worked", I mean, for every single year, you could have theoretically put your money (about $4000 per "unit") on the table and either:
1) Been dead wrong and have been able to recoup 100% of your investment.
2) Been right and had an opportunity to make, at a minimum, a 50% return on the investment, with many years being substantially more.
This is all math, and may put some of you to sleep, but if you can wade through all this, I am certain you will come to the same conclusion I have. This IS an opportunity to put your money in a highly leveraged position and have a very strong possibility of getting it all back, or, make an extremely attractive return. It goes without saying (but I will), as good as this may look, this could be the one year that defies the past 25 and you could lose every dollar you invest.
First stop: Every December Bond contract going back 25 years. The table below lists where the market closed on the first trading day of June, then whatever the biggest move was in either direction between then and expiration almost 7 months later. The 3rd column is what is really of importance here...
Bonds are quoted in points and 32nd's where each full point equals $1000 per contract.
The smallest move was 4 26/32, or $4400 a contract.
19 of the 25 years had a move of at least 7 points.
14 of the 25 years had a move of at least 8 points.
The chart below outlines the position and hopefully will help you see what I see....
But summarizing first...
December Bonds are trading almost dead on 109. If you buy 2 December 111 calls and 1 December 109 put, the total cost at today's close would be $3917.
If bonds go down 4 points, the 109 put would be 4 points or $4000 in-the-money. You sell it and own the calls for free. (In actuality, about a 3 1/2 point down move would mean you could unload both the put and the calls and recoup $4000).
If bonds go up 5 points, to 114, the two 111 calls would each be $3000 in-the-money or worth $6000 total (at least). This is a 50% return. At this point, you can take the money, or sell one, or enter stops, or just let it all ride (most moves are more than 5 points) with the two calls increasing in value about $2000 for each point the market moves up.
Here is the chart which is a little jammed with information but really presents the whole picture as regards movement and dollars involved...
And this may be overkill, but I'll now include all of those charts for the past 25 years. You can see for yourself that BONDS DO MOVE between now and year end...MY WHOLE POINT IS, WHATEVER YOUR OPINION OF THIS MARKET, DUE TO THE FACT EXPECTATIONS FOR MOVEMENT ARE QUITE LOW (which is a whole story in itself) BOND OPTION PRICES ARE CHEAPER THAN I THINK I HAVE EVER SEEN THEM. THIS IS THE BASIC REASON WHY THIS OPPORTUNITY (TO SCRATCH TRADE OR SCORE) IS "AVAILABLE" THIS YEAR.
Each chart notes the first close in June, then the highest move up or lowest move down between then and expiration...and finally the size of the move...
I haven't mentioned a word as to why I think Bonds are a buy here...Suffice it to say I have my reasons but I have enough information already on this page without going into a longwinded discussion as to "why I think I'm right". If you have read this far, I'm going to throw one more bit of statistics at you.
Taking those same 25 years, at some point between January 1st and expiration, the December Bond contract has had some sort of rally in every one of those 25 years. THERE ARE A FEW SMALL ONES, BUT IN 21 OF 25 YEARS, THAT RALLY WAS FOR AT LEAST 9 POINTS. THE LARGEST RALLY IN THE DECEMBER CONTRACT, SO FAR THIS YEAR, IS JUST A HAIR OVER 4 POINTS. This certainly doesn't mean they do have to go up from here but it certainly suggests it is a strong possibility...and again, all we need is 5 or 6 points to make this trade have been "worthwhile". Here's one more table and one more look at the December 2007 contract.
The point here is Bonds tend to have a pretty good rally (even in bear market years) at some point in almost every year.
That's more than enough data for one newsletter. Nothing is ever a "lock" in this stuff, but give me this sort of statistical "set up" and I will put the money at risk EVERY time. How often can you make a bet and have this strong of a possibility of either, at worst, breaking even, or being in a position to generate a 50% (or better) return? This may not work, and it may be a total loser, but from a risk-reward standpoint, I don't see how it gets any better than this.
Give me a call if you want to know more....