• Market:  September 2006 30-year T-Bond (USU6)
• Tick value: 1 point = $15.625
• Option Expiration: 08/25/06   
• Trade Description: Bear put butterfly spread. 
• Max Risk: $390.625
• Max Profit:  $1,609.375
• Risk Reward ratio 4:1

Buy one September 2006 30-year T-Bond 107 put, also buy one September 30-year T-Bond 103 put, while selling two September 30-year T-Bond 105 puts, for a combined cost and risk of 25 points ($390.625) or less to open a position.

Technical / Fundamental Explanation
Bonds have been in rally mode since the last FOMC meeting in June. We have recently seen a very large number of indicators issue sell signals on this market, Stochastics, and CCI to name just a few. The consensus is that the Fed. will move rates to 5.50% at the August 8 meeting. After that it is about a 50-50 guess as to if the Fed will pause or continue raising. The yield curve remains inverted and T-Bonds struggled with the 108 handle. With Oil maintaining itself above $74 a barrel and other key commodities like copper at or near all-time highs, the signs of continued inflation are clearly written on the wall. Overall this is a low cost way to be short bonds going into and trough the next FOMC meeting. With inflation fears still front and center we should see bonds move back towards the lower end of the range as we get closer to the August 8 FOMC meeting. This trade achieves max profit if the market grinds its way back to the lower end of the range as you can see on the chart below.

Profit Goal
Max profit assuming a 25 point fill is 103 points ($1609.375) giving this trade a little better than a 4:1 risk reward ratio. Max profit occurs at expiration with 30-year T-Bond trading at 105. The trade is profitable at expiration if the 30-year T-Bond is trading any where between 106-19 and 103-13 (break-even points) which means we have a band over three basis points in 30-year T-Bond that we can profit in.

Risk Analysis
Max risk assuming a 25 point fill is $390.625. This occurs at expiration with the 30-year T-Bond trading below 103 or above 107.

Derek Frey is Head Trader at Odom & Frey Futures & Options.

Disclaimer
Past performance is not indicative of future results. Trading futures and options is not suitable for everyone. There is a substantial risk of loss in trading futures and options.