3 options transactions to take advantage of rising interest rates

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Interest rate movements spill over into financial markets, stimulating some areas while weighing on others. The recent rise in inflation and the economic recovery are prompting investors to seek out the Federal Reserve to reduce asset purchases and possibly start raising rates. While the pace will be gradual and it may be another year or more before we get the first rate hike, markets are already starting to take heed. To benefit from the new leadership, we are sharing three option trades that will benefit from it. .

Rather than focusing on single stock ideas, we’ll tap into broad themes that have historically performed well with rising trade rates.

Thus, we seek to build bullish positions in sectors that benefit from an increasing rate regime and bearish trades in areas that are suffering.

Additionally, we will be using Exchange Traded Funds (ETFs) to avoid any drama surrounding earnings reporting or other idiosyncratic risks that accompany single stock bets.

That said, here are the tickers in play today:

  • IShares 20+ Treasury Bond ETF (NASDAQ:TLT)
  • ETF SPDR S&P Regional Bank (NYSEARCA:KRE)
  • SPDR Fund for the Energy Sector (NYSEARCA:XLE)

After reviewing the price chart and explaining how each fund moves with rates, we’ll share a smart idea for options trading.

Profit option transactions: IShares 20+ Treasury Bond ETF (TLT)

Source: TD Ameritrade thinkorswim® platform

The first idea is the simplest. Bond prices move inversely with interest rates. So when rates go up, bond prices go down. While most bond ETFs are boring and lack sufficient volatility to attract traders, the TLT has enough movement to make it interesting. This is because it tracks long-term bonds, which are the most sensitive to interest rates.

Since the 10-year rate broke last month, the TLT has reversed. It is now below all major moving averages and has just broken through another support area at $ 143.50. In May, when the 10-year yield peaked at 1.7%, the TLT fell to $ 135.35. This is, ultimately, the target of its current bearish movement, and it provides $ 7 of potential profit for the bears.

To capitalize, I like to use sell spreads.

Options trading: Buy the December bearish $ 142 / $ 135 sell spread for $ 2.50.

You risk $ 2.50 to earn $ 4.50 if the TLT is less than $ 135 at expiration.

SPDR S&P Regional Bank ETF (KRE)

ETF chart of regional banks (KRE) with bullish breakout

Source: TD Ameritrade thinkorswim® platform

The rise in long rates improves the profitability of banks. The logic is simple and follows from their economic model. Basically, banks borrow money from depositors while lending to borrowers for mortgages, auto loans, business loans, etc. Short-term interest rates determine what they pay depositors, and long-term interest rates dictate what they charge borrowers. The greater the difference between the two rates, the greater the profitability of the bank.

The recent surge in 10-year rates came as short-term rates remain stuck at zero, improving banks’ bottom line. This dynamic plays out in each economic cycle, making banks one of the main beneficiaries of a rate hike regime.

KRE has completely ignored the recent market pullback. Indeed, it almost looked like an inverted ETF, rising as everything went down. We are now a stone’s throw from a new record, and I think the strength will continue. Bullish diagonal buy spreads provide an excellent match with typical KRE price behavior.

Options trading: Buy the December $ 69 call while selling the November $ 73 call for a net debit of $ 2.85.

As long as KRE is above $ 70, you will make a profit on expiration. If it exceeds $ 73, the reward increases to $ 1.50.

Profit option transactions: SPDR Fund for the Energy Sector (XL)

Energy sector (XLE) stock chart with increasing bullish momentum

Source: TD Ameritrade thinkorswim® platform

The only other sector that has historically matched banks’ outperformance when rates rise is energy. Indeed, the inflationary pressures which push the rates upwards are due in part to the rise in oil prices.

And, of course, when crude goes up, it takes energy company revenues with it.

The past month saw a strong ramp in XLE amid heavy build-up. With oil prices eclipsing the pivotal resistance near $ 75 this week, silver should continue to flow into the energy sector, making it our final choice for options trading.

Options trading: Buy the November bullish $ 55 / $ 60 buy spread for $ 2.15.

You risk $ 2.15 to earn $ 2.85 if XLE exceeds $ 60 at expiration.

As of publication date, Tyler Craig was long XLE. The opinions expressed in this article are those of the author, subject to the publication guidelines of InvestorPlace.com.

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