This is a "for-the-record" type post and picks up on the topic of the previous entry, "Operation Twist Is Totally Skewed" of 22 March.
As an indicator for the long term US Treasury market, let's use NYSE:TLT, which was around 112 at the date of the article and has generated two (interest based) "dividend" payments for a combined $0.5735. Today TLT looks set to open around 123.50. Shorting TLT has resulted in a loss. Writing puts against the short position has more than covered the dividends. Provided short term, slightly out of the money puts were written the total loss on the position to date will have been around 4-6%.
NYSE:NLY, being the largest agency mortgage REIT (and the issue with the most actively traded options), is a reasonable indicator for the agency paper market. NLY traded around $16.20 on the 22nd of March, has paid a dividend of $0.55 and looks set to open around$16.50. Some additional income could have been generated by writing slightly out of the money covered calls.
On balance, world bond markets are still awaiting the final act of the ongoing Greek tragedy (The Final Act of an Entertaining Greek Tragedy, 30 January, 2012), and this last act has caused US treasuries to spike - now is the time to increase the short position (always remembering to partially hedge and generate cash to cover "dividends"). As to NLY and its ilk, maintain current positions, look forward to continuing dividends and establish partial hedges by writing calls.
The US Long Bond finally rolled over at the end of July. TLT managed to hit 132 on 25 July. One factor important to TLT's appreciation is it's imperfect relationship to the Long Bond. First, it's supposed to reflect the Barclays 20+ year US government bond index. Second, costs (slippage and dealing costs) impact TLT's performance. Remaining bearish on longer term rates, the recent Long Bond and TLT price action can been seen as parabolic, formed by a classic overbought market, and recent price action, as we're headed down the other side of the mountain, is nothing but normal. Perhaps there's a bit of a dead cat bounce as Operation Twist spasms. Trading out of the TLT put options during the recent upswing has been profitable, but hedging by being short at a price of in excess of 130 has been tough to deal with, then again, it's not like TLT is a takeover candidate - the ultimate, "reasonable", downside is that the "US becomes Japan", in which case TLT would trade at around 160. Whether this risk is acceptable depends on allocations - the edge is there, so an allocation of between 10-20% to this trade - probably for several years makes sense.
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