Since the Presidential election there have been some significant moves in the price of different Treasuries, especially the 30-year Bond. The symbol for Bond Futures is /ZB and the Bonds that are deliverable against the contract can have 15-25 years until maturiry. TLT is an ETF that most closely resembles Bond Futures and is based upon a 20-year index. Although they are similar, there are some important differences, especially in their option pricing. What are those differences and why do they exist? TP joins the guys to explain it all.
TLT is often used as an alternative to /ZB in an equity account. There is no dividend in /ZB though and it has a zero cost to carry. One difference that attracts our interest as premium sellers is that Implied Volatility (IV) in TLT is consistently higher than in /ZB. As you would expect, this means that TLT’s options, on a relative basis, are higher priced. The amount that TLT’s IV is higher changes over time. The reason for the difference in IV is that TLT’s portfolio of Treasuries is more volatile than the Treasury Bonds that would be used to deliver on the Futures contract. They are known as “cheapest to deliver” because they are the least expensive Bonds that would fulfill the specifications of the Futures contract. Since 2011, TLT’s daily returns have been 27% more volatile than /ZB’s. A bar chart displayed the Volatility of daily returns, per quarter, from 2011 to 2016.
Modified duration measures the sensitivity of a Bond or Bond portfolio to a change in interest rates. The higher the modified duration the higher the sensitivity. It’s calculated by taking the net present value of the future coupons (the Bond payments) and adjusting it by the current yield. Longer dated Bonds will have a higher modified duration and modified durations will be higher when yields are higher. TLT’s modified duration is 26 which is 30% higher than the 20 of /ZB. That corresponds to the 31% higher volatility of returns over the past month. Taking the price of TLT and dividing it by the price of /ZB results in a price ratio. That number fluctuates, of course, but is currently around 0.79. We can then take that number and adjust the option prices of Puts and Calls in /ZB for TLT using strikes with the same Delta. A table displayed an example which showed that, when adjusted for price of the underlyings, TLT options are prices around 28% higher which is consistent with both the modified duration and IV.
Watch this segment of Skinny on Options Modeling with Tom Sosnoff, Tony Battista and Tom Preston, aka TP, for the important takeaways and a better understanding of why TLT options are priced higher than /ZB options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.