3 Options Trades to Profit from Rising Interest Rates

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Interest-rate movements ripple through the financial markets, boosting some areas while weighing on others. The recent inflation uptick and economic recovery have investors looking for the Federal Reserve to taper asset purchases and eventually start raising rates. While the pace will be gradual, and it may yet be a year or more before we get the first rate hike, markets are already beginning to price it in. To benefit from the new direction, we’re sharing three options trades that will profit.

Rather than focusing on single stock ideas, we will exploit broad-based themes that have historically played well with the rising rate trade.

Thus, we’re looking to build bullish positions in the sectors that benefit from an increasing rate regime and bearish trades in areas that get hurt.

In addition, we will use exchange-traded funds (ETFs) to sidestep any drama surrounding earnings reports or other idiosyncratic risks that accompany single stock bets.

That said, here are the tickers in play today:

  • iShares 20 Plus Year Treasury Bond ETF (NASDAQ:TLT)
  • SPDR S&P Regional Banking ETF (NYSEARCA:KRE)
  • Energy Sector SPDR Fund (NYSEARCA:XLE)

After reviewing the price chart and expanding on how each fund moves with rates, we’ll share a smart options trade idea.

Options Trades to Profit: iShares 20 Plus Year Treasury Bond ETF (TLT)

Source: The thinkorswim® platform from TD Ameritrade

The first idea is the most straightforward. Bond prices move inverse to interest rates. Thus, as rates rise, bond prices fall. While most bond ETFs are boring and lack sufficient volatility to attract traders, TLT possesses enough movement to make it interesting. This is because it tracks long-term bonds, which are the most sensitive to interest rates.

Ever since the 10-year yield broke out last month, TLT has been rolling over. It’s now below all major moving averages and just broke through another support zone at $143.50. In May, when the 10-year yield peaked at 1.7%, TLT fell to $135.35. That, ultimately, is the target for its current down move, and it provides $7 of potential profit for bears.

To capitalize, I like using put spreads.

Options Trade: Buy the December $142/$135 bear put spread for $2.50.

You’re risking $2.50 to make $4.50 if TLT sits below $135 at expiration.

SPDR S&P Regional Banking ETF (KRE)

Source: The thinkorswim® platform from TD Ameritrade

Rising long-term rates boost the profitability of banks. The logic is simple and derives from their business model. At their core, banks borrow money from depositors while lending to borrowers for mortgages, auto loans, business loans and the like. Short-term interest rates determine what they pay to depositors, and long-term interest rates dictate what they charge to borrowers.  The greater the spread between both rates, the greater the profitability of the bank.

The recent surge in the 10-year yield has transpired while short-term rates remain pinned at zero, thus boosting the bottom line for banks. This dynamic plays out in every business cycle, making banks one of the biggest beneficiaries of a rising-rate regime.

KRE has wholly ignored the recent market pullback. Indeed, it almost looked like an inverse ETF, rising while everything was falling. We’re now a stone’s throw from a new record high, and I think the strength will continue. Bull call diagonal spreads offer an excellent match to KRE’s typical price behavior.

Options Trade: 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’ll snag a profit at expiration. If it rises beyond $73, the reward grows to $1.50.

Options Trades to Profit: Energy Sector SPDR Fund (XLE)

Source: The thinkorswim® platform from TD Ameritrade

The only other sector that has historically matched the outperformance of banks when rates are rising is energy. This is because the inflationary pressures that push rates higher are due in part to rising oil prices.

And, of course, when crude climbs, it carries the revenue of energy companies higher with it.

The past month has seen a robust ramp in XLE amid heavy accumulation. With oil prices eclipsing pivotal resistance near $75 this week, money should continue to flow into the energy sector, making it our final pick for options trades.

Options Trade: Buy the November $55/$60 bull call spread for $2.15.

You’re risking $2.15 to make $2.85 if XLE climbs above $60 by expiration.

On the date of publication, Tyler Craig was long XLE. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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