Prepared by Jack McIntyre

Short-term strategy (next week or two). October T-bond options. Buy the October 114/111 put spread for 1-07/64 or better. There are 30 days until expiration. (Strategy #2) Longer-term strategy (next couple of months). Buy the December 112/116 call spread. If the December T- bond contract is trading near 111-16 over the next 30-days this call spread should be trading near 1-04/64s. There are currently 86 days until expiration.

We are looking at the October and December options on the December T-bond contract because the September options on the September T-bond contract stop trading this Friday.

The title of this comment sort of says it all. The U.S. Treasury market (basis the December T-bond contract), has during its trading pattern over the last several sessions, defined the 114-00/114-03 area (which also coincides with 6.50% on the 30-year cash bond), as a major resistance area. The 114-03 area is the 50% retracement of the sell-off from 116-20 to 111-18. The 38% and 50% retracement levels typically generate some type of market reaction. In this case, selling and it just so happens that this area brings attention from the cash traders being so close to 6.50%. If we are right about the selling pressure in bonds continuing, we expect to see another case of a lower low and high. This is something we have not seen over the last several trading sessions (except for yesterday), and if these types of chart patterns unfold it would signal that more downside is in store near term. Keep in mind, that even though the large traders have significantly reduced their T- bond holdings, they are still holding a sizable net long position and another round of long liquidation could unfold. Particularly, if the December T-bond contract closes below 113-00. This should take the contract back toward the 112/111 area before the rallies resumes.

Interestingly, the pull back from 116-20 to 111-18 was slightly more than a 38% retracement of the huge rally from 105-26 to 116-20. In fact, the sell-off in the market we are expecting could take the contract all the way to 111-07 (the 50% retracement of this rally) and still maintain a “bigger picture” bullish bias. This is why we plan to look at buying call spreads with the December options on the December T-bond contract. We like the 112/116 call spread when the contract trades back into the 112- 16 to 111-07 area (we priced it at 111-16 and it should be trading close to 1-04/64s.

Implied volatilities on the December options have been bid up over the last several weeks. This stems from option traders demanding slightly higher premiums based on an increase in the market's directional uncertainty. Bonds have not trended for several weeks now and in consolidation markets implies typically rise.

Bottom line, we expect near-term weakness in the bond market, but are maintaining a more constructive tone during the latter part of the third quarter into the end of the year.

August 21, 1997 MCM, Inc.

294 Washington St, Ste. 734, Boston, Massachusetts

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