Are the 10-year Treasury yields hitting a wall at 5%? It may be time to get bullish on U.S. equities using the Nasdaq 100. Here’s a strategic way to approach relenting yields and a bounce in tech (rate-sensitive) stocks. Federal Reserve Chairman Jerome Powell on Thursday dovishly acknowledged continuing optimistic signs of cooling inflation, but also strategically straddled the interest rate fence stating that the central bank will remain “resolute” in its commitment to its 2% mandate. The highly anticipated speech moved the 10-year yield lower to nearly 4.90% as another rate hike in 2023 seemingly has become less likely. November’s meeting has a 98% chance of another pause but, his speech has now pushed the odds of yet another pause at the December meeting up to a surprisingly dovish 75% (per the CME Group’s Fedwatch tool which measures futures contracts by real traders). This fortifies my thesis that the Fed is done raising rates. However, after Fed Chairman Powell properly positioned his words during the subsequent on-stage interview, bond vigilantes found a few Powell sound bites to lean into their commitment and pushed the 10-year note yield back up and achieved their seemingly 5% target yield (prices moved lower as yields and futures prices are inversely related). US10Y 5D mountain 10-year Treasury yield, 5-days From a former U.S. Treasury futures trader who has traded various interest rate cycles over multiple decades, this has been an unrivaled parabolic move in Treasury yields. The 10-year note started 2022 off at 1.55% and 2023 roughly at 3.75%. Trading following Fed Chairman’s speech was volatile as investors grappled with understanding the actual timeline associated with the Fed’s recent tagline of “higher for longer”. All of this was digested in the wake of 30-year mortgage rates flying above 8% this week, the highest level since 2000. Investors are bracing for the next Fed meeting in less than two weeks. As Chairman Powell’s measured words reiterated, the Fed is wary of declaring victory over inflation although the Fed will most likely hold interest rates steady now for the rest of 2023. Looking past the Fed, investors must remember that we are off to a positive start in the Q3 earnings season, with most companies not only beating estimates but also providing reassuring guidance for the coming quarters. Risk reversal trade As I believe that the 10-year note yield will relent after its meteoric rise and after finally printing 5%, I want to attempt to capitalize in the most rate-sensitive index of the three U.S. major indices. The Nasdaq 100 continues to be rate sensitive and has had a more than 10% recent pullback per below chart. Embracing the recent surge in volatility ( Cboe Volatility Index now over 21) can allow an investor to finance a bullish view. As I believe yields will relent and the Nasdaq 100 will resume its 2023 move higher (QQQ +35% ytd), I want to use the recent increase in option premium to establish a bullish view for a credit. The option strategy that I will utilize is a credit spread but, better known as a risk reversal. This credit spread can be established by selling an out-of-the-money put and using the premium collected in writing that put option to buy an upside OTM call. The same expiration will be used for both the put and the call options. Looking to sell the regular expiration December $350 put for $8.70 (which is 2.5% lower from 10/19/23 close) Looking to buy the regular expiration December $370 call for $8.10 The result in the sale of the put and the purchase of the call resulted in a credit spread collecting $0.60 cents or in contract terms, collected $60 per 1 contract and have the ability to participate in the upside for the QQQs above $369.40 Typically, a risk reversal is a hedging strategy that protects a long or short position by using put and call options simultaneously. This strategy can protect against unfavorable price movements in the underlying position but also limits the profits that can be made on that position. If an investor is long a stock, they could create a short risk reversal to hedge their position by buying a put option and selling a call option. No cost…with a catch This risk reversal is being used as an aggressive bull trade. Since I am buying a higher strike price call option and financing the premium paid by selling an out-of-the-money put option, I am essentially putting on a bull trade for close to no cost or even a credit. If I am correct, and the QQQs continue to trade higher, the short put will become worthless, and the long call will increase in value-generating a considerable profit. However, this comes with a catch. If I am incorrect about the ETF’s movement, I will be forced to buy the stock at the short put strike price. This strategy is considered risky and could generate significant losses. All short put options run the risk of being assigned to the trader and they’ll need the capital in their account to cover that. Being forced to buy the QQQs lower than where I initially opened the risk reversal is still a better outcome than if I would have simply purchased the stock outright. While there is a lot of time before this option strategy expires, there is an opportunity to manage this spread as it either moves for or against me. To be clear, this strategy favors a short-term bullish view on U.S. equities which is predicated on U.S. treasury yields finally taking a breather and moving lower by year end. In the event you have a “half glass empty” view, you could be on the other side of this trade by buying the put and selling the call…remember, there are always two sides to a trade. DISCLOSURES: (Owns QQQ, Short QQQ $350 puts, Long $370 QQQ calls) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. 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This story originally appeared on CNBC
