Friday, September 25, 2009

TLT-TBT Pair - New Position

A portion of my covered call portfolio is allocated to fixed income investments, for which I've chosen iShares Trust Barclays 20 Year Treasury Bond Fund (TLT). Some members of the JustCoveredCalls Yahoo Group use ProShares UltraShort Lehman 20 plus Year Treasury (TBT), which corresponds to twice the daily inverse of TLT.

Last year I experimented with pairs trading using DIA-DXD, by doing a covered call (CC) paper trade. I discovered that DXD, which is twice the daily inverse of DIA, had quite a bit of tracking error over the long term, and as such was not a good long term ETF to own.

However, after recent discussions regarding TBT, I decided to take a look at a pairs trade using TLT-TBT. I downloaded the closing prices of both ETF's since the inception of TBT (5/22/08) through this week. I then created a chart of the closing prices and inverted the chart for TBT so that both charts could be easily compared. I noticed that TBT tracked pretty close to TLT. I also noticed that both ETF's typically traded in a relatively small range of prices, except for a three month period starting in Oct 2008 and ending in Jan 2009.



So, I decided to try another pairs trade, this time doing cash secured puts (CSP) on TLT-TBT with real money. I chose OTM strikes for Nov expiration. For TLT, I sold the Nov09 94 Put at $1.19, which gives me downside protection to $92.81. For TBT, I sold the Nov09 43 Put at $1.24, which gives me downside protection to $41.76. Looking at the charts, the downside protection on both appears to be below a recent support level, but that's no guarantee, as anything can happen between now and Nov expiration.

Combined, these two positions should return 11.56% annualized if both expire in Nov. I'm going to maintain them as separate positions until Nov. If they expire, I'll add the proceeds to my ongoing TLT position. If the TLT put is assigned, I'll also add that to the ongoing TLT position (i.e. average down). I'm going to try to avoid getting assigned on the TBT position, since I don't want to own it long term, but will use it to generate additional short term income for the ongoing TLT position.

The following is the trade information, including IB commissions:

TLT Position

CSP Margin Used: $9,400.00
Income Generated: $119.00
Percent Income Generated: 1.27%
Annualized Income Generated: 8.25%
Net Profit If Expired: $119.00
Percent Return If Expired: 1.27%
Annualized Return If Expired: 8.25%
Days Held to Expiration: 56 days

TBT Position

CSP Margin Used: $4,300.00
Income Generated: $124.00
Percent Income Generated: 2.88%
Annualized Income Generated: 18.80%
Net Profit If Expired: $124.00
Percent Return If Expired: 2.88%
Annualized Return If Expired: 18.80%
Days Held to Expiration: 56 days

Combined Position

CSP Margin Used: $13,700.00
Income Generated: $243.00
Percent Income Generated: 1.77%
Annualized Income Generated: 11.56%
Net Profit If Expired: $243.00
Percent Return If Expired: 1.77%
Annualized Return If Expired: 11.56%
Days Held to Expiration: 56 days