Bonds are going on tilt. How to play them, says Mike Khouw

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Warren Buffett once said interest rates are to asset prices what gravity is to matter. If the options market is correct, things could get heavy.
Case in point: the TLT, the iShares 20+ Year Treasury Bond ETF, which seeks to track the performance of an index of U.S. Treasury bonds. A quick review of the fund's holdings shows that the shortest-dated maturities are just shy of 20 years away, February 2046, and the longest-dated maturities are almost 30 years away, August 2056.
Most investors consider U.S. Treasurys the safest investment in the world, and I've heard people say that because the obligation is repaid in U.S. dollars, which the government can and does create out of thin air, the U.S. cannot (or should not) ever possibly default.
To the extent that people mean there is no real credit risk (a risk that the borrower cannot repay the debt), I agree. But credit risk is not the only risk that bond investors face. They also have rate risk. When interest rates rise, bond prices fall. A bond's sensitivity to changes in interest rates is a function of the maturity of the bond. The longer the maturity, the greater the sensitivity to interest rate changes, all else equal.
This was a lesson long-term bond investors learned very painfully when long-term interest rates started rising in 2020. TLT fell ~52% from the 2nd half of 2020 through late 2023. Total returns, net of interest rates, were a little better due to coupon payments, but only slightly, because the coupons were so low. Since then, 30-year U.S. Treasury rates have largely been range-bound between the highs and lows of Q4 2023, until the past several weeks, when they broke definitively above the 2023 highs. They rose another 7.6 bps today, and options traders have been taking notice. TLT traded ~ 1.6 million option contracts on Thursday, nearly double the average daily volume, and the 856,750 put contracts traded were ~3.3x the average.
The most active contract was the October 79 put, with 123,649 contracts traded at an average price of $0.4786 per contract. One of the largest trades was the October 80/79 put spread, which traded 65,000 contracts for a net debit of $0.275 per spread, a nearly $1.8 million bet that TLT, which closed at $80.78 after hitting an intraday 52-week low of 80.665, will drop below the $80 put strike by at least the premium paid. A trader betting that TLT will fall is betting that long-term rates will rise, adding pain to the housing trade and others that need to borrow long-term money at ever-higher rates, the biggest of whom is the U.S. government itself.
Whether or not you believe rates will stabilize, observe that this is a bet that pays better than 2.6:1 if TLT falls to $79 or lower by October expiration. That's a decline of $1.78 in 35 days. If that seems like a lot for a long-dated Treasury bond to move, consider this. That's how much it moved between Tuesday morning's highs and Thursday afternoon's lows.
Disclosures: Tidal owns/holds all the securities mentioned in the article.
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