wmeubank@ocp.kcmo.com
FISHBACK MANAGEMENT & RESEARCH
P.O. Box 23798, Lexington, Kentucky
(December 4, 1997) FINANCIAL INSTRUMENTS: MARCH BOND FUTURES–Our bond market model remains bullish. Sentiment is neutral, while interest rate trends are bearish. But there are two bullish factors at work. First, the yield curve is positive and is actually widening out a bit. Second, and this is even more critical, gold prices and gold stocks are totally collapsing. While that is bearish for gold, it is very bullish for bonds. Therefore, any trade we take, we'd prefer a slight bullish bias.
The trouble is that volatility, which has been low for about the last week, has plunged. Implied volatility is at its lowest level in months. And the six-day volatility is now less than 2%. Volatility readings that low have only occurred 4 other times in the past ten years. The dates are show in the very left-hand column. The column to the right shows the price of the front-month bond contract at that time. The columns to the right of that represent the point of maximum departure from the time in which bond volatility fell below 2%. Note that in three out of four instances, the bond market made a rather dramatic move. The largest move occurred the last time that volatility plunged. Bond prices collapsed, falling over 8 points in a five-week span.
Point of Point of Magnitude low volatility maximum departure of move 4/11/90 92-11/32 4/26/90 88-19/32 down, 3-24/32 2/12/92 99-26/32 2/24/92 98-10/32 down, 1-16/32 9/28/95 112-31/32 11/8/95 118-7/32 up, 5-8/32 2/9/96 119-7/32 3/15/96 110-19/32 down, 8-20/32
Right now our indicators are telling us that the next move is likely to be higher. But we can't be sure. Fortunately, with options, you don't have to be sure. All we have to do is be right that the magnitude of the moves in the days ahead will be greater than anyone expects. But you must be patient. The method of operation in a low volatility environment is to put on your option position and then wait. We've already got one position on. We were filled in our ten-year T-note March 111 straddle position last week. We are going to implement one more position and then that will be it. Then we'll have to wait for a catalyst to come along. For accounts of less than $5,000, you may want to take a pass on this one. The total cost of the new recommendation will be such that the total open position commitment to those two trades will be nearly $5,000.
RECOMMENDATION–Buy the March 120 call (settle, 1-38/64) and buy the March 118 put (settle, 1-21/64) for a maximum debit of 2-58/64 or better. If you can't enter the trade by Tuesday's close, cancel your order and wait until further instructions.
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