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What strategy says about Treasuries

David Russell (david.russell@optionmonster.com)

If you're looking for movement, don't look to Treasuries.

That was the message of one big trade yesterday in the ProShares UltraShort 20+ year Treasury bond fund, which is looking for the TLT to stay trapped in a range. A block of 5,000 contracts each traded in the January 2014 21 puts for $5.20 and the January 2014 21 calls for $3.40. Volume was more than 80 times open interest in both strikes.

The trader collected a credit of $8.60 in this short straddle , which he or she will get to keep if the TBT closes at exactly $21 on expiration. Gains will erode on either side of that price, but the position will make money anywhere between $12.40 and $29.60. (See our Education section)

The TBT rose 1.95 percent to $19.32 yesterday and has lost more than half its value in the last year. The option play is interesting because it seems to rely on several factors that could keep the fund range-bound.

First, the Federal Reserve has promised to keep interest rates low through at least the middle of next year. That will likely support the price of long-term Treasuries. Given that TBT moves in the opposite direction of bonds maturing in at least 20 years, this could keep the fund from rallying.

Second, leveraged funds are usually subject to time decay . They usually perform well when the underlying index moves, but otherwise tend to gradually lose value.

Those are the forces that will keep the TBT from rallying. On the other hand, the investor may also think it won't fall dramatically because the yields on long-term bonds are already near record lows.

That could hamper price appreciation, which is what's required for the TBT to fall hard. The improving economy and job market would also keep a lid on bond prices.

Overall, the short straddle reflects a belief that long-term bonds will be stable over the next two years, with prices expected to decline only moderately and yields inching higher.

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