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Thursday, February 5, 2009

An Update on the Ten Year Bond Play

At the end of December, I recommended an aggressive investment involving the ten year bond. At the time, the ten year bond was trading with an interest rate near all time low. At the same time, President Obama was looking for a robust stimulus package in which he would borrow somewhere in the neighborhood of one trillion Dollars. I made the assertion that if the government was going to engage in such a mammoth amount of borrowing that the market would demand a much higher rate. I targeted January 15th because at the time it appeared that President Obama might have walked into office with a stimulus bill waiting for him. My idea was to buy a call option on the bond. A call option would make the bet that the interest rate would go up.

Now, since then here is what the ten year bond has done.
So after reaching all time lows in late December, the rate on the ten year bond has been going up ever since. As such, had you taken my advice in middle of January, you would have made some profit now.
The reason that the ten year bond rate has gone up is because the market finally woke up to what I spoke of. Suddenly, the market realized that one trillion Dollars in new spending would put all sorts of upward pressure on the rate on Treasury Bonds.
Now, we sit with the rate on Ten Year U.S. Treasury bonds at near 3%. At its low, the rate was just over 2%. The rise in the rate on the ten year is in anticipation of a massive spending bill being passed.
As such, right now, it's unclear what will happen. If you took my advice, you should have made some money. There is no doubt, in my mind at least, that there will be volatility in the rate of the ten year bond. What is unclear is which way it will go. As such, if you have already made my play, I would take some profits, and buy an option the other way. As such, you would have what is called a straddle. In other words, you would now be rooting for volatility.
Ultimately, the direction of the ten year bond depends on what sort of a stimulus passes. If a stimulus passes in the neighborhood of what President Obama wants, we are likely to see the ten year bond continue up for a while. If one doesn't pass, you are likely to see the ten year bond dive to all time low rates of around 2% again. Even if a compromise is reached and a smaller stimulus passes, you are likely to see the rate drop.
As such, what will happen in the next week will affect the ten year bond dramatically. Stay on top of the action as the future of this investment will be largely determined by it.

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