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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.