Fed Ending Treasury Purchases

This is significant - the purchases are what kept interest rates low. I believe now is the time to begin scaling into a series of trades that take advantage of declining bond prices and increasing rates.

Here's the premise: we're at the beginning of a trend where we see an increased desire for risk assets ... selling treasuries and buying stocks, alongside rising rates (within 6-12 months).

How do we do it? As of this writing you can take in $0.34 a share buying 200 shares of TBT and selling 100 shares of TLT.

This strategy uses ETFs in a long/short play that minimizes (or increases) the cash in your account. On the downside, it takes $9400 in buying power to execute the trade in a standard retail margin account.

Why should it work? When interest rates rise, bond prices decrease. You can buy a fund that increases twice the percentage of a fall in bond prices. You can pay for it by selling twice the number of shares of a fund that increases the same percentage as a gain in bond prices. When bond prices decrease, the value of the fund you bought rises and that of the fund sold decreases. When its time to close out the trade (both sides!), you sell the fund that has increased in value and buy the fund that has decreased in value.

How do you lose on the trade? If the stock market drops, investors will shift their holdings to what they perceive as safer assets (government bonds). As demand increases, bond prices will increase and rates will decrease. Second, one of the less understood features of these ETFs is tracking error - the variance between what the fund achieves and the change in its underlying index. That is one reason why ETFs are are considered short-term hedging instruments.

Third, if the markets stay range-bound .. say up 10% Monday, down 10% Tuesday, and so on through the following Monday, here's what happens to $100:

Mon	+10%	110.00
Tues	-10%	99.00
Weds	+10%	108.90
Thu	-10%	98.00
Fri	+10%	107.80
Mon	-10%	97.00

The bond went up 10% three days, down 10% three days and instead of back to even, the trade is down 3% !

I do expect periods where the behavior goes against us. I also expect to hedge the trade and move in and out of the trade more than several times over the next 3 years.