Players scoop up TLT puts, expect US yields to rise

CHICAGO, March 13 Thu Mar 13, 2008 5:52pm EDT

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CHICAGO, March 13 (Reuters) - Investors flocked to put options on an exchange-traded fund used as a U.S. Treasury bond market surrogate on Thursday, in the belief that longer term U.S. yields are poised to rise, options traders said.

A report by credit rating agency Standard and Poor's that the worst is over in subprime-related write-downs for large financial institutions helped lift U.S. stock prices and undermined the need for U.S. Treasuries as a safety play.

U.S. Treasury bond prices also slipped on hopes a new federal housing initiative would eventually remedy the crisis of confidence in mortgage-backed bond markets.

Shares in the iShares Lehman 20+ Year Treasury Index (TLT.A), or TLT, which tracks the long end of the Treasury yield curve, fell 90 cents to a session low of $93.40.

In the options market, TLT put volume far outpaced call volume by a factor of 8.32. In all, roughly 29,000 puts and 3,431 calls changed changed hands in the TLT, two times the normal volume, according to option analytics firm Trade Alert.

"Investors are buying puts in the TLT on the view that the yields on Treasuries are set to rise and bond prices will move lower," said Peter Dunay, chief investment strategist at broker-dealer Meridian Equity Partners in New York. "So in effect, investors are betting that the TLT shares will fall further."

Investors often use equity puts, allowing them to sell the security at a predetermined price within a specified time period, to guard against downside market risk.

In this case, when the fund loses value, bonds are falling and yields are rising. So betting against the TLT by purchasing puts would be a way to bet that long-term rates will rise, said independent options trader Frederic Ruffy.

There has been another bout of flight to quality buying this week in the financial markets as the global liquidity and credit crisis that began last summer rumbled on.

"The flight to safety motivated some bond buying," Ruffy said. It also spurred an increase in risk perception reflected by the elevated Chicago Board Options Volatility Index .VIX or VIX, and a rally in gold prices to a record $1,000 an ounce.

"However, when Standard and Poor's suggested today that there might be a light at the end of the tunnel for the banks and brokers, bonds lost some of that flight to safety bid," Ruffy said.

Also, the U.S. consumer price index data, which has important implications for inflation and Federal Reserve policy, is due out on Friday.

"Some bond traders probably banked some profits and move to the sidelines ahead of the news," Ruffy said.

The exchange traded fund typically attracts nontraditional bond investors such as smaller hedge funds and individuals. (Editing by Leslie Adler)

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