Options traders seem to be bracing for downside in junk bonds as negativity sweeps financial markets.
The iShares High Yield Corporate Bond ETF (HYG) is having its worst month in over three years as investors shun leveraged companies. The largest options trade so far today occurred in he the fund:
- A block of 35,000 February 79 puts was bought for $0.76.
- A block of 35,000 February 76 puts was sold for $0.22.
- That translates into a net cost of $0.54.
Owning puts fixes the price where investors can sell a security. Writing them generates income and creates an obligation to buy if a certain level is reached.
This morning’s transaction combines both strategies into a spread, effectively letting the trader collect $3 from HYG dropping down through $79 to $76. Considering how much they paid, that’s a potential profit of 456 percent from the underlier moving less than 8 percent. See our Knowledge Center for more on the leveraging power of options.
HYG slid 0.57 percent to a new 52-week low of $80.88. The fund has crumbled even as Treasuries surged higher. That’s pushed junk bonds to their widest yield spread against risk-free government securities in over two years, according to the ICE BofAML US High Yield Master II Option-Adjusted Spread.
What’s behind the carnage? Volatility in the S&P 500, fear and an historic breakdown in oil prices — that’s what. Weakness in stocks makes investors less willing to take risk. There have also been worries about the economy. But the selloff in oil has been huge because a lot of domestic energy companies are financed in the high-yield market.
In conclusion, junk bonds have taken a beating and options traders see risk of further downside.