We know that Bond yields have recently hit record lows. That means Bond prices are near their highs. The S&P 500 and other major indexes are at or near their record highs. Since there is a high negative correlation between stocks and Bonds (-0.83 over the last 15 years) perhaps a Pairs Trade going short Bonds and short the S&P would make sense. How exactly would we do that?
An example of trying to take advantage of this established negative correlation via a Futures Pairs trade by shorting the S&P 500 Future (/ES) and shorting the Bond Future (/ZB) was displayed. The example included the capital required and the notional value for each future sold. This choice is capital intensive and a problem for someone with an IRA account.
A table of a possible Pairs Trade using options in TLT (Bond ETF) and SPY (S&P 500 ETF) was displayed. The strategy was a short Vertical Call Spread in the TLT and a long Put Spread in the SPY. The table included the strikes used, credit/debit, breakeven prices, max profit and max loss. This trade adds a Theta (time decay) component and the lower margin cost means much less in buying power reduction (BPR). The Futures Pair used $10,931 in BPR and the options only $371. A graphic of the Profit/Loss versus the stock price on the SPY Put Spread and the TLT Call Spread was displayed.
For more on related subjects see:
Strategies For Your IRA from January 12, 2015: "Short Bonds, Short Market"
Market Measures from March 25, 2015: "ETF Relationships | Bonds and the S&P 500"
From Theory To Practice from June 20, 2016: "The Short Side: Stocks & Bonds"
Watch this segment of Strategies For Your IRA with Tom Sosnoff and Tony Battista for the key takeaways and an exploration of Pairs Trade strategies using Futures or Options take advantage of record prices in stocks and the Bonds in an IRA account.
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