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Trade of the Month
By Head Trader James Mound
http://www.moundreport.com
T-Bond Long Strangle - Friday, August 9th

Trade description:
Buy one September 30yr T-Bond 108 put & buy one September 30yr T-Bond 109 call for a cost of between 80 – 85 ($1250 - $1328.13) on Tuesday, August 13th before 11:30am eastern time. Margin and max risk is the cost of the trade. Options expire Saturday, August 24th. Please note that the strike prices may change as the trade is intended to strangle the price of the market. If the market is between 108-109 then the above strike prices are to be used, but if the market should be above or below that range, then the strike prices should be adjusted accordingly prior to entering into the trade.

Explanation:
The recent increase in bond volatility over the past several weeks is mainly due to stock market fluctuations and speculation over possible rate cuts. On Tuesday, August 13th the FOMC meets to determine interest rate policy and a possible rate cut. Analysts and market participants have the biggest split in opinion of what the Fed will do as has been seen in a number of years. With most of the market split between no cut and a 25 basis point, and even some well respected economists suggesting a possible 50 basis cut, there is the potential for an explosive reaction from the market after the report. Rather than guess as to direction, a strangle allows for profit from the volatility rather than the correct calling of the direction of the market following the meeting (Please see one of the August Featured Articles, “Why Spread Options” for more details).

**Chart courtesy of Gecko Software’s TracknTrade.

Profit Scenarios:
Profit scenarios vary by market activity and exit strategy, but in theory is unlimited. The concept behind the trade is that the movement of the market and the increase in value of one side of the strangle exceeds the total cost of the trade. However, if the market looks to have choppy price action, or to trade both positive and negative before the expiration of the options, then legging out of the trade when each side reaches profitability would yield maximum returns. It is recommended to exit one side on a profit of $500 over and above the cost of the trade, and to hold the other side for a possible reversal.

Risk Scenarios:
Max risk is the cost of the trade. Time value works against you from the moment the volatility expected from the Fed announcement subsides. To reduce exposure it is recommended that you enter into two spreads allowing you to exit 50% of the profitable half of the trade (for example, on a bond selloff, exit one of the two puts, and hold the two calls) when breakeven occurs on the spread.

Disclaimer: Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

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