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Will the Fed Remain an Aggressive Participant in the Market?

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At this point, the iShares Barclays 20+ Year Treasury Bond ETF is a safe bet, but that could change after the Fed's June 18 meeting.

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The iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is definitely something speculators will be keeping a close eye on over the next few days. We are getting close to the June 18 meeting, which is when the Federal Reserve board will decide whether they will retreat from bond buying or if they will remain aggressive participants in the market. In the meantime, the ETF has been reacting negatively to the latest employment report issued on Friday and yet the June 13 options have been trading today at unprecedented high levels. In midday trading today, a trader sold 27,000 TLT June 117-113 put spreads, clearly a bullish position.

The St. Louis Fed President James Bullard spoke today on why the Fed will stick to its aggressive bond buying campaign as opposed to easing up on it. US inflation remains well below the Fed's 2% target, which may signify that the Fed will continue its aggressive asset purchase program. Furthermore, Bullard said that the Fed did not want to taper off from purchasing bonds when the price pressure continues to fall. Consensus among economists is divided between the Fed pulling back by the end of September or the end of December. Of the economists polled, 35.1% believe that the bank will begin to pull back in September; another 35.1% believe the bank will begin to pull back in December. No economists polled believed that the Fed will pull back after its June 18 meeting.

It seems that for now TLT remains a safe bet. However, speculators should keep their ears to ground and closely follow any news from the Fed in the next couple days leading up to the June 18 meeting.

Trade: On May 13, 2013, a trader bought 53,000 TLT June 117-113 put spreads for $1.16 debit.

Risk: $116 per one lot

Potential Reward: $284 per one lot

Cash Outlay: $6,148,000

Breakdown: This trader now received $7.566 million, netting a profit of $1.418 million and still has paper gains of $4.725 million that he/she is letting ride with hopes of turning those paper gains to $10.8 million.

Full Disclosure: I am long the TLT June 117-114-111 put butterfly for $.53 debit.

Unusual Option Activity: We define unusual option activity as large block trades that represent a large percentage of daily option volume. The block trade is considered "unusual" if the option volume is above the average daily volume over the past 22 days. At my firm, we scan and analyze order flow from all of the major options exchanges in order to identify any unusual option activity.

Analyzing unusual order flow gives traders a window into what the positions that large institutional players have. The majority of unusual option activity can be traced back to hedge funds, mutual funds, and other large institutions. Knowing where these institutions are placing their bets can be hugely advantageous for any trader. These institutions have informational and technological advantages that the average trader doesn't have, and the amount of time and analysis that goes into every one of their trades is substantial.

Order flow can however at times be deceiving. One might logically thing that a large block buyer of calls is bullish on the underlying. This is not always the case. Remember that a large number of participants in the equity options market are hedgers. Long calls are a hedge against short stock, and long puts are a hedge against long stock. With this in mind we have developed a 7-step trading plan that helps filter out unusual option activity that will not provide actionable trade setups. It is by using this plan that we are able to identify the most significant unusual options activity trades every day.
The author is long the TLT June 117-114-111 put butterfly for $.53 debit.
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