Trading Nation

Here’s how one trader is playing a curious relationship between stocks and bonds

Here's how one trader is playing a curious pattern between stocks and bonds

One trader has taken notice of an ongoing trend between bonds and equities, and plans to play for more upside in a Treasury bond-tracking exchange-traded fund.

The iShares 20+ Year Treasury Bond TLT ETF has been rallying in tandem with the S&P 500-tracking SPY ETF, pointed out Todd Gordon, founder of Bonds and stocks typically move inversely, so the congruent relationship is particularly interesting to him.

"There's some interesting strength going on here, and it could be telling us one of two tales," he said Thursday on CNBC's "Trading Nation," examining a chart of the TLT, which has gained nearly 7 percent this year, and the SPY, which has rallied nearly 11 percent in the same time.

"Either the bond market is telling us that the Fed is going to be on hold for a longer period of time and continue to be accommodative and supportive of this stock market rally — so then you can see stocks and bonds moving together. Or, are traders positioning for a coming sell-off in stocks and increasing volatility?" he said.

"That's telling me that bonds are either moving higher because of coming risk aversion or the Fed is really just behind this market and not going to take their foot off the gas pedal," he said.

Gordon plans to bet on further upside in the TLT, as he sees a "pending double-top" in a chart of the ETF. Trading at $127 on Friday, the fund may resume higher above $128, which would give way to upside in the $130 region.

To capitalize on what he sees from a technical basis, Gordon plans to execute an options trade. He is buying an October monthly 128-strike call, pairing that with the sale of an October monthly 132-strike call for a total cost of $1.14 per share, or $114 per options spread.

The trade breaks even at $129.14, which is the strike price of the lower call plus the per-share cost of the trade. If TLT closes at or above $132, he will enjoy his maximum profit of $286 per options contract. Meanwhile, if the TLT closes below $128 per share on the contract's expiration date, he will lose his $114 entire initial investment.

"We're buying some time in this trade," Gordon said, as the October monthly options contracts expire about a month and a half away, on Oct. 20.

"If that gets cut in half, down to about $57 per options spread, cut the trade, contain the risk; it's' not working. Move on. Otherwise, we're going to be looking for that gap close up through 130 in this interesting TLT rally that we're seeing," Gordon said.