“Turn ‘em into North Tortilla”

– Rear Admiral James Evans Jr., 14th Naval District (Pacific Fleet)


There will be a great deal of tension and market volatility in the days leading to a resolution of the current impasse with North Korea, and of course, we all hope for a peaceful and just outcome without resort to force.


That said, both the rhetoric and activity of the last few days have been increasingly explosive, and it’s our opinion that a military clash of some variety is presently in the making.


Whether it be limited or ‘overwhelming’ – as one senior cabinet appointee proclaimed – it will no doubt be short-lived.  There’s little chance of a long-lasting, attritive battle between the two Koreas and their sponsors.  There’s simply too much at stake, too much hardware primed to launch and too much ill-will between the sides for anything but a) a limited, short-lived escalation that immediately cools under pressure from the relevant third parties (China and Russia), or b) a full-bore race to annihilation of one side or the other that leaves untold damage and death in its wake.


Either way, it will be fast.

Our best estimates of a time frame are based on the current level of rhetoric, the speed at which it ratcheted higher, the willingness of the North Koreans to launch and detonate extraordinarily powerful weapons and the need for both sides to prove their bona fides.


Bottom line is – the thing has to come to a resolution, peaceful or otherwise, within three to five months or America comes away a loser.


And in the meantime…


The lead-up to hostilities, if indeed they come to pass, will move markets significantly, with pressure on certain sectors more than others.


And it’s to those pressures and sectors that we turn for this week’s trade.


Right after we deal with a single, open trade.


This one was opened a long time ago, on the 24th of December, 2015.  The letter was called Drilling Down to the Bond Core, and in it we wrote of an imminent sell-off in the bond market that, to this day, has yet to transpire.

The trade called on you to buy two (2) TLT January (2018) 100 PUTs for $4.25 each and sell one TLT January (2018) 124 CALL for $7.20, for a total debit of $1.30.


And today, with TLT trading at $128.79… friends, we’ve got a problem.  The short 124 CALL due this January is close to $4 in-the-money.


And how do we deal with that?


Well, for starters, we have to admit that it’s more than likely TLT will continue heading higher over the intermediate term, according to the charts we’re offering below.


So why don’t we break to have a look at them before we address a fix for the trade.


We start with the monthly chart for the iShares 20+ Year Treasury Bond ETF (NYSE:TLT), which looks like this –

Over the last decade, shares of TLT have moved higher in waves that brought a succession of higher highs and higher lows, the quintessential action of a stock in a bull market (red circles).


At the same time, we note that at no time in the last nine-plus years has the monthly chart seen an overbought reading.  It did briefly reach such a level in late 2008 at the height of the Lehman panic (in blue), but quickly sold off thereafter.


Moreover, in the last two months RSI and MACD indications have moved above their respective waterlines (in green), indicating that a bullish trend is still in place.


Taken together, the above confirms that there’s currently little reason to worry that a steep retracement lower is in the offing – according to monthly indications.


Now to the weekly chart, which depicts four years of trade in TLT –

Here, we see positive indications from RSI and MACD gauges beginning in mid-July, when MACD confirmed RSI’s push above her waterline some two months prior, in early May (in green).  This alone is a positive, bullish signal, but when added to the action of the weekly moving averages (in blue), we find additional reason to believe that the long bond is now ready to push significantly higher.


Consider –


  • All the moving averages are trending higher, and price is above them all – a glorious signal for the bulls.


  • And while the weekly MAs are not completely unfurled, the short term (blue) moving average is but five or six weeks from crossing higher, and we believe it will accomplish that feat even if prices stall at the current level for a month.


But that’s not likely to happen.


A look at the daily chart confirms why.

The daily price action shows TLT slicing convincingly through the last line of overhead resistance at 128 yesterday (blue circle).  Resistance came from the long term (411 day), yellow moving average.


With that line crossed, and three of the four daily MAs trending northward, we see great promise on the long side of the Treasury trade.  TLT is now trading at its highest level since last November’s election, and with the current milieu of uncertainty surrounding the conflict in Korea, natural disasters striking one after another and a potential government shutdown looming – among other things – we say safe haven flows into U.S. bonds will start to gather momentum.


And as there’s no sign of excessive passion behind the current buying, we could have a long way to run (in green).


In our opinion, it’s now time to buy back the short TLT CALL we sold way back when, and reverse the trade to pay for it.


And it goes like this –

- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]

Many happy returns,


Matt McAbby

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