Monday, March 22, 2010

Establish ProShares UltraShort 20+ Year Treasury ETF Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of ProShares UltraShort 20+ Year Treasury ETF(TBT) covered calls as follows:

Established ProShares UltraShort 20+ Year Treasury ETF(TBT) Covered Calls for Oct09:
03/22/2010 Bought 300 TBT @ $46.81
03/22/2010 Sold 3 TBT Apr2010 $48.00 Calls @ $.45

TBT seeks daily investment results, before fees and expenses, which correspond to twice the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury index. The fund normally invests at least 80% of assets to investments that, in combination, have economic characteristics that are inverse to those of the index. It also typically invests in taking positions in financial instruments, including derivatives that should have similar daily return characteristics as twice the inverse of the index.

This advisor has done a lot of reading lately on the present factors impacting long-term interest rates and is convinced that the preponderance of the evidence supports a belief that a cyclical low in long-term interest rate yields is near. One important rationale is that Treasury Note and Bond issuances are very large, and the appetite of foreign countries, especially China and Japan, for continuing their aggressive purchasing at Treasury auctions has begun to subside. Also importantly, the Federal Reserve has recently announced that their purchases of mortgage-backed securities will cease at the end of this month. Moreover, with the Federal Funds Rate at 0%, the future direction of rates will undoubtedly be higher, despite the fact that the timing of this outcome is very unpredictable. Each of these trends, along with the exit from recession and now the beginnings of worldwide economic growth also portend a greater likelihood for higher Treasury Bond yields.

This ETF was mentioned by a participant during a monthly conference call of the Yahoo 'JustCoveredCalls' Group. After an appropriate amount of due diligence, it was determined that this would be a good way to establish a covered calls position that reflects this advisor's belief in the likelihood of higher treasury yields during the next few months. Some readers would ask: Why establish an out-of-the-money position in an inverse ETF instead of simply an in-the-money position in a direct investment (such as TLT)? In short, an out-of-the-money position in the inverse TBT ETF enables for the possibility of capital appreciation in the underlying ETF and thus a substantially higher potential return-on-investment than could be achieved from an in-the-money TLT position if interest rates do in fact trend slightly higher.

Two possible overall performance results (including commissions) for the TBT transactions would be as follows:
Stock Purchase Cost: $14,051.95
= ($46.81*300+$8.95 commission)

Net Profit:
(a) Options Income: +$123.80
= (300*$.45 - $11.20 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If TBT price unchanged at $46.81):
-$8.95 = ($46.81-$46.81)*300 - $8.95 commissions
(c) Capital Appreciation (If TBT exercised at $48.00): +$348.05
= ($48.00-$46.81)*300 - $8.95 commissions

Total Net Profit(If price unchanged at $46.81): +$114.85
= (+$123.80 +$0.00 -$8.95)
Total Net Profit(If TBT exercised at $48.00): +$471.85
= (+$123.80 +$0.00 +$348.05)

Absolute Return if Unchanged at $46.81: +0.8%
= +$114.85/$14,051.95
Annualized Return If Unchanged (ARIU): +11.5%
= (+$114.85/$14,051.95)*(365/26 days)

Absolute Return if Exercised at $48.00: +3.4%
= +$471.85/$14,051.95
Annualized Return If Exercised (ARIE): +47.1%
= (+$471.85/$14,051.95)*(365/26 days)