Trader makes $1 million bet on big bond rally

One trader just made a million dollar bet that bonds will see an even bigger rally

The bond market spooked investors this week — and some traders are expecting the bond breakout to continue.

The yield curve is at its flattest point in more than a decade, causing traders' fears of an economic slowdown to rise. The move sent the Dow plunging more than 800 points on Tuesday to close about 3 percent lower and sparked a flurry of activity in the options market.

The sell-off saw the long-term Treasury bond ETF, the TLT, trading at three times its average daily options volume on Tuesday. According to "Options Action " trader Mike Khouw, options traders are speculating the trend will continue.

"Like we saw in a lot of areas of equity options and ETF options [Tuesday], it seems like there was a lot of hedging activity, speculation that things could get a little bit worse," Khouw said Tuesday on CNBC's "Fast Money. "

Khouw highlighted a buyer of 20,500 January 121/127 call spreads paying $0.52 per contract. Since each options contract accounts for 100 shares, this is a more than $1 million bet the TLT could rise as high as $127, or another 8 percent by January expiration.

According to Khouw, options premiums didn't see the kind of sell-off spike on Tuesday that they usually do, allowing traders to get in and scoop up contracts as a way to hedge their equities bets.

The lack of a spike was a good opportunity, and traders were "trying to take advantage of that, and get a little hedging in while they still could," said Khouw.

Shares of the TLT traded around 2 percent higher on Tuesday, closing at $117.82.