You don’t have to be a bond trader or follow every self-appointed TV expert to keep a studied eye on interest rates. In fact it can be done much more easily by watching a bellwether ETF.
And it’s a good time to pay attention. Just recently, the Federal Reserve changed the tone of its stance on rates, indicating that we could see little change into this summer or fall before it dials the rate needle upward.
Once rates do start to inevitably increase, we can use ETFs to profit from the change. But we can also exploit rising rates’ effects on the big brokers – one in particular – and employ a simple options technique to maximize our gains. I’ll show you how.
How I “Watch” Rates Through ETFs
I regularly watch the iShares Barclays 20+ Year Treasury Bond ETF (NYSE Arca: TLT). This largely mimics the Treasury bond market.
Use Options to Maximize Profits and Mitigate Risk
I like Interactive Brokers (Nasdaq: IBKR) stock. It clearly ranks better than the rest, and looks like a great long-term buy for a rising rates environment.
Right now, 100 shares of Interactive Brokers will cost about $3,200 plus commissions. Another alternative would be a September call option, granting you the right to buy Interactive Brokers at a price of $32. This call option is trading right now at a price of $2.25, which is significantly less than buying the stock for $32 a share.
If the stock were to rise to $40 by September, you would make $8 on each share, representing a 25% ROI. However, with that exact same move in the Interactive Brokers the call option would be worth a minimum of $8, and the fact that you paid only $2.25 for it gives you a better than 300% ROI.
Okay, so you might ask what if rates don’t rise, and Interactive Brokers fell $8 instead of moving higher? The stock trader would see a loss of $8 a share, while the most the option trader would lose on this position is the cost of the option ($2.25), a far cry from the cost of buying the stock and having it move against us.
Either way, for those of you who are short bonds and long brokers, here’s to higher rates!