Option probabilities spell possible trouble for Treasuries

What the March 2014 put option chain is telling probability based option traders is that implied volatility levels are indicating that there is a 68% probability that TLT closes above $99/share. There is a 90% probability that price closes above $91 / share at the March monthly expiration. Now we will look at the call side of the March 2014 TLT option chain.

The closing price on November 13, 2013 was $104.52/share. A 1 standard deviation (68% probability) corresponds to the 107 strike. A 2 standard deviation move (90% probability) corresponds with the 112 strike. Thus, there is a 68% probability that TLT closes below $107/share at the March monthly option expiration. There is a 90% probability that price closes below $112/share.

So what does this data tell option traders looking at probabilities? The answer is simple. The TLT March 2014 options’ implied volatility levels are telling us that presently the marketplace believes that TLT has a higher probability of being lower than today’s closing price of $104.52/share on March 21, 2014.

There is a 68% probability that the price of TLT at the March expiration will be between $99 - $107/share. There is a 90% probability that the price of TLT at the March expiration will be between $91 - $112/share.

The one standard deviation upside strike is $107/share which is just 2.37% above $104.52/share. The downside strike is $99/share which is 5.28% below today’s closing price. Based purely on those numbers, there is nearly a 2 : 1 probability that TLT’s closing price on March 21, 2014 will be below today’s closing price of $104.5/share.

The same situation is true when we look at the 2 standard deviation predicted price range. The 90% probability upside target is $112/share which would correspond with a 7.15% move to the upside. However, the 90% downside target is $91/share which would correspond with a 12.93% move to the downside from today’s closing price.

I want to be clear that this does not mean TLT’s price will go down for sure. It is merely a road map as to what TLT’s option chain is indicating about future price action. It is without question that the implied volatility levels in March TLT options indicate that there is risk ahead regarding Treasury bonds.

Whether the risk revolves around the debt ceiling debate or a possible taper from the Federal Reserve is hard to know for sure, but at this point TLT is nearly 2 times more likely to move lower in the months ahead.

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About the Author
J.W. Jones

J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. He is  primary analyst and moderator of OptionsTradingSignals.com and expert market analyst and chief options analyst for TradersVideoPlaybook.com.

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