You’ve probably heard the old saying that only two things in life are truly certain — death and taxes.
It’s rare to find a trade I’m 100% certain on.
But I’ve done it.
I see a trade that is as close to certain as I’ve ever seen — and if you make the right move today, I think it could quadruple your money in two years.
These situations are rare in general. In the stock market? They’re unheard of.
This is an opportunity you want to grab with both hands.
Here’s the situation.
Right now, we know with certainty the Federal Reserve is going to raise rates. We don’t know when. We just know it’s a matter of time.
After its last meeting, Fed officials released a dot plot projecting interest rates out to 2024. This chart shows most policymakers expect at least two interest rate hikes in 2023. More than a third expect interest rates to rise in 2022.
In other words, we can be confident the Fed’s key rate — which was slashed to near-zero in the wake of the COVID-19 pandemic — will start to rise again in the next couple years.
This might not sound like a huge deal. If you’re plugged into what’s going on in the financial world, you might even dismiss it as common knowledge.
But it’s how one applies this knowledge that separates mere market observers from the world’s best traders.
By applying this knowledge today, you have the potential to quadruple your money with a specific long-term options trade.
All by using a setup that, in my view, is practically guaranteed.
When the Fed Raises Rates, This Will Fall
So we know interest rates will go up. That means bond rates will go up.
When bond rates go up, bond prices fall.
So when we consider that the Fed is planning to hike rates sometime in the next two years, and use a bit of simple math, we find an incredible trade setup…
If a bond was issued last year at 1%, it’ll still pay 1% in 2023.
But if current interest rates rise to 3% by then, no one will want a 1% bond. To attract buyers, sellers drop the price of the bond. They cut prices until the annual payout matches the current interest rate.
You see, bond prices are different from stocks in that they aren’t as directly affected by supply and demand. It’s all about the interest rate. There are even formulas that inform exactly where bonds will go as interest rates change (namely the Macaulay Duration, which is too complex to dig into today).
Using these formulas with the Fed’s dot plot, we can determine where bond prices are headed. And when applied to the right bond ETF, we can start to construct the trade.
The best one to use is the iShares 20+ Year Treasury Bond ETF (NYSE: TLT), because it has the highest duration of non-leveraged government fixed income assets. With no leverage and the backing of the Federal government, we have a near guarantee that the yield on TLT will pay out and the price should behave according to interest rate changes.
Considering the duration on TLT is 18.5 (essentially the ETF’s sensitivity to interest rate changes), we know its price will drop about 18.5% for each 1% increase in rates.
If the Fed raises rates to 1.75% in 2023 — the high-end estimate on the Fed’s dot plot — that would represent over a 40% drop in the value of TLT.
You can probably see where I’m going with this.
We have the chance to profit handsomely from a put option as TLT enters a long-term downtrend.
As you know, when stock prices fall, put options on those stocks can increase in value.
While it is a bond ETF, TLT trades like a stock. So buying a TLT put option expiring in 2023 offers a low-risk trade on the Fed’s plans.
Here’s where it gets interesting…
Most low-risk trades have small profit potential.
The profit potential on this trade is substantial.
TLT is trading at about $143. An option expiring on January 23, 2023, with an exercise price of $145 is trading for about $15. The symbol for this option is TLT230120P00145000.
Buying this put option gives you the right to sell TLT for $145 per share by January 23, 2023. For that right you pay a $15 premium — or, as each option contract controls 100 shares of stock, $1,500 per contract.
The further TLT falls, the more profitable this put option becomes…
But just how profitable?
How to Quadruple Your Money Betting on the Fed
To find a profit target for the trade, we need to make some assumptions about interest rates.
The current yield on TLT is 1.5%. The yield is low because the Fed is buying bonds to keep rates artificially low — as it has been for over a decade, barring a minor period of balance sheet unwinding from 2017-2019.
If the Fed let the market set the price, the rate would be well above 2%. That’s because rates on long-term bonds should reward investors for lending money, compensate them for inflation, and provide a premium to protect against the risk of default. (Government bonds don’t have a risk of default so only the first two factors apply.)
Bond yields averaged 4-6% until the 1900s. After World War II, they fell to 2-4%. Since the financial crisis of 2008, the rate has been near zero because central banks around the world spent trillions of dollars to stimulate economic growth.
Assuming the Fed sticks to the dot plot, interest rates will rise to at least 2% plus the rate of inflation. If we give the Fed the benefit of the doubt and assume the current inflation spike to 5% is indeed transitory, and the Fed achieves its target of 2% inflation, interest rates on long-term bonds should rise to 4%.
In short, higher rates are almost certain. As the risk of higher rates rises, investors will demand larger returns from Treasury bonds. If inflation exceeds 2%, this will only increase that demand.
At a minimum, we should expect a 2.5% increase in interest rates. That means TLT would fall more than 40%.
At that level, the Jan 2023 $145 puts will be worth more than $57, a potential gain of 280% based on the recent price of the puts.
That’s the gain I expect assuming the Fed starts raising rates next year. If that happens, the market should adapt quickly to the higher rate environment, causing a precipitous drop in TLT.
Even if that scenario is delayed, we’re still looking at triple-digit gain potential over the next year.
And keep in mind, this assumes the Fed is completely right about inflation numbers coming back down. If the Fed is wrong and inflation continues to run hot, this trade will return even more.
Bottom line, this trade could at least quadruple your money in two years. I can’t find a trade with better odds right now… This is it.
Michael J. Carr CMT CFTe
Editor, One Trade
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