ETF Prophet

Login
Our Flickr Channel Our Facebook Our RSS Feed follow us on twitter
BZB Trader

Following yesterday’s introduction, this is a Delta Neutral setup using TLT and TBT to create a safe, albeit muted revenue stream. The setup requires selling calls to generate premium income, so positions are required to be  in 100 share lots.  In addition, we’ll collect dividends on the TLT side of the trade. The positions and sizing look like this:

Buy 100 TLT @ $104,  Sell Jan Call @ 5.10,  6 month dividend = .62

Buy 200 TBT @ $27,  Sell Jan Call @ 1.69, no dividend

A 1 lot position cost is 104+ 27×2 = 158 x100 = $15,800.

Projected return is 5.10 + .62 + 1.69×2 = $ 9.10 x 100 = $ 910.

APR return is approx. 910/15800 = .057 x 200 = %11.4

Note that although TBT is the ultra inverse of TLT we must hold a double position in TBT to maintain daily cash equivalency. We re-up the setup every 6 months in lieu of leap positions in order to increase option premium decay.

So what can wrong with this scenario?  Risk #1 is that the calls will be exercised in either TLT or TBT, leaving the position  unbalanced.  Risk #1 is a real likelihood given the range of the markets and we counter this factor by simply re-establishing our called position on the day of the exercise, thus preserving our dividend return and maintaining the delta balance.  Risk#2 concerns TBT’s inherent decay function that creates a skew with TLT’s price.  This skew is variable over time but can be forecast using the BZB DN algorithm, the net effect of which is a supplemental short term TBT option position to offset the skew.

This is just one example of delta neutral thinking that can be employed to deliver low risk returns. There are other variables that may affect the net outcome of this setup and I welcome reader feedback on the idea.

 

 


3 Responses to “Delta Neutral Thinking – Part 2”


  1. Very interesting trade idea!

    How about selling puts instead? Less margin and dividend is mostly in put option so lowers risk of getting called away before you collect dividend (I think)?

    I am very interested to hear more of your delta neutral ideas.


  2. Thinking about this more….Is buying 100 and 200 really a neutral trade? Don’t you need to buy/sell the same dollar amount (adjusted for the 2x TBT)? So $10,000 for TLT and then $5000 for TBT for example? That gives you the number of shares to buy. Then selling calls get’s a little more complicated because of the 100 lot issue.

    Maybe I’m missing something but I have done a lot of pairs trading in the past and this was the first step: $ neutral positions.


  3. BDI,
    The trade is $ balanced……
    TLT @ 104 x 100 = $10400
    TBT @ 26.50 x2 = $5300 (x2 lev) = $10600
    The beta of TBT is the wild card and if you look back over the life of TBT you’ll notice the rapid beta decay, especially the first year of issue. Hence the need for a dynamic fudge factor.

    The put idea also has merit but really serves option savvy traders willing to buy the increased risk.It would be interesting to run some preliminary return numbers though. The DN example was posted in response to a number of readers wanting to know if there was a safer investment tactic for their IRAs.