To understand TBT, first we must look at another ETF, iShares Barclays 20+Year Treasury Bond Fund (TLT).  This bond fund is comprised of 9 different US Treasury Bonds with maturities ranging from 2029 through 2038.

Fundamentals of TLT (as of 12/31/08)

Over the past year and half, as investors have become increasingly more risk averse with the economic downturn, many investors have been moving their money from equities into much safer US Treasuries.  The flood of new investors into the US government bond arena has raised bond prices which, in turn, lowers bond yields.  In other words, investors are willing to pay a hefty premium for much lower returns on US Treasury Bonds because they are guaranteed by the US government.  In a sense, investors are parking their money in Treasuries until it’s “safe” to get back in the equity pool.


For a quick bond refresher, bonds, like the US Treasury Bonds, have $1,000 face values which is considered to be a $100 par value (why?  I don’t know).  So, let’s assume that a 30yr US Treasury bond is issued with a coupon rate of 4% and we have a expected rate of return of 4%.  We would be willing to purchase that bond for $1,000, because it would be at par value.  However, if our expected rate of return is greater than the coupon rate, then we would expect to receive a discount on the price of the bond like maybe $950, or if our expected rate of return were less than the coupon rate we would be willing to pay a premium for the bond like $1050.  In fact, very rarely does a bond trade for par value.  It usually trades at a discount (<$100) or at a premium (>$100).


As of right now, the average weighted price of TLT is $131.01, which means you would have to pay $1,310.10 to receive $50/year and $1,000 after 25.72 years (according to the weighted averages listed above).  Buying this basket of bonds and holding them to maturity would yield us 3.25%.  Historically speaking, 3.25% is extremely low for 30 year Treasury yields (see chart below):

So now the question becomes, “How can we take advantage of such historically low yields in long term US Treasury Bonds?”


Enter ProShares UltraShort Lehmans 20+YR Treasury Fund ETF (TBT).

In the world of bonds, yields are inversely related to prices.  As yields go down, prices go up.  As yields go up, prices go down.  Clearly, yields have fallen steadily since 1980, but have really dropped off even more sharply in the last few months, or so, to what I think are unsustainable levels.  Right now, investors are more comfortable with an expected rate of return of 3.25% which causes the long term US Treasury Bonds to be priced at $131.01.  However, as the economy gets back on its feet and the stock market becomes more attractive, investors will begin having a much higher expected rate of return and US Treasury Bond yields will go back up.  As they go up, the bond prices will have to fall, hopefully approaching their par value of $100.  TBT is setup to take advantage of the falling Treasury prices by shorting TLT with leverage, so instead of a -1 correlation, there will be a -2 correlation.  A 10% fall in TLT should produce a 20% gain in TBT.  The leverage doesn’t always work out nicely because of daily fluctuations, but in general, if we see a large fall in TLT, TBT should come out a huge winner.

-Joey