Investment Reflection: Poor Man’s Covered Call on TLT
Overview of Strategy
On November 18, 2024, I executed a poor man’s covered call (PMCC) on the iShares 20+ Year Treasury Bond ETF (TLT) $iShares 20+ Year Treasury Bond ETF(TLT)$ , employing a diagonal spread strategy. This involved:
Buying a long-dated call option with a strike price of $84 and a maturity date of April 17, 2025, at a cost of $745 per contract.
Selling a short-term call option with a strike price of $92 and a maturity date of November 29, 2024, earning a premium of $21 per contract.
At the time, TLT was trading at $89.80, and the strategy was based on a short-term bullish outlook, leveraging seasonality and technical factors that suggested a potential year-end bounce in Treasury bond prices.
Analysis of the Trade
The Rationale:
The decision to implement this PMCC was influenced by seasonal trends and a temporary positive outlook for long-term Treasurys. Historical data suggested that TLT typically sees a seasonal upswing in the final trading days of the year, with gains in 17 of the last 22 years (77% success rate).
This seasonality was supported by technical analysis and the expectation of a short- to intermediate-term rally in bond prices due to factors like reduced rate-cut fears and a period of stability in the Federal Reserve's monetary policy.
The PMCC was a cost-efficient way to take advantage of this anticipated short-term bounce while hedging the risk of a long-term commitment to bonds in a still-bearish macroeconomic environment.
Strengths of the Strategy:
Leverage and Reduced Capital Requirement: The use of a long-dated deep ITM call ($84 strike) provided exposure to TLT at a lower upfront cost compared to purchasing 100 shares outright. This allowed for efficient capital allocation.
Premium Income: Selling the short-dated $92 call generated $21 in income, offsetting some of the cost of the long call and reducing the break-even point.
Seasonality Alignment: The timing leveraged a strong seasonal pattern, increasing the probability of favorable price action.
Weaknesses and Risks:
Limited Premium from Short Call: The $21 premium was relatively small compared to the cost of the long-dated call ($745), providing minimal immediate income and limited downside protection.
Volatility and Macro Risk: Despite seasonal trends, the long-term macro environment for bonds remained bearish, with high yields (4.544% on the 30-year Treasury) and concerns over inflation, fiscal deficits, and economic resilience.
Short-Dated Expiration: Selling a call with a short maturity (November 29) limited the income opportunity from potential upside beyond that date.
Market Action and Outcome:
If TLT remained near or below $92 by November 29, the short call would expire worthless, allowing me to retain the premium while holding the long call for further price appreciation.
If TLT moved significantly above $92, the profit would be capped at the difference between the strike prices ($92 - $84 = $8 per share) plus the net premium collected.
Reflection on the Strategy
Outcome Evaluation:
The strategy was well-suited for a short-term bullish view on TLT, with the PMCC structure reducing capital outlay and leveraging seasonality.
However, the bearish macro backdrop for bonds highlighted by high yields, fiscal concerns, and Federal Reserve policy risks underscored the speculative nature of this trade.
Improvements and Lessons:
Targeting Higher Premiums: Selling a short call with a closer-to-the-money strike or a slightly longer expiration date could have generated higher premium income, improving the risk/reward balance.
Managing Macro Risks: A more cautious approach might involve waiting for confirmation of price action (e.g., breaking key technical resistance levels) before committing to the trade.
Sizing and Diversification: Given the broader uncertainties in the bond market, limiting the position size or pairing it with complementary trades (e.g., credit spreads on Treasury ETFs) could have mitigated risk.
Broader Implications:
Seasonality Alone Isn’t Enough: While seasonality was a key driver of this trade, it should have been weighed more heavily against the macroeconomic headwinds. Seasonality works best when aligned with broader market conditions.
Flexibility with Rolling: A PMCC allows for flexibility in rolling the short call to future expirations or adjusting the strikes as market conditions evolve. Keeping this option in mind can help manage unforeseen price movements.
Conclusion
This PMCC strategy on TLT reflected a calculated attempt to capitalize on seasonal strength in Treasury bonds while managing capital efficiently through options. While the trade aligned with historical trends, the bearish macro environment for long-term bonds posed a significant risk to the short-term thesis.
Ultimately, the success of this strategy depends on whether TLT sees the anticipated seasonal bounce before November 29. If not, the long-dated call retains potential for future gains, albeit at a higher cost basis. This trade serves as a valuable reminder of the importance of balancing short-term optimism with macroeconomic realities and fine-tuning option strategies to optimize income and reduce downside exposure.
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