On Wednesday, the Federal Reserve raised interest rates by 25 basis points, marking the first time the U.S. central bank has done so in nearly a decade. Prior to the Fed meeting, high-yield bond exchange traded funds, including the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest high-yield corporate bond exchange traded funds, saw massive increases in trading volume.
The two marquee junk bond ETFs also saw notable increases in options market activity as options traders prepared for the Fed announcement.
“On Tuesday, when the HYG was up more than 1 percent, someone bet $1 million that the ETF will continue to fall for the next month. The trader purchased 25,000 of the January 77/74 put spreads for 40 cents each. This is a bearish strategy where someone will buy a put and sell a lower strike put of the same expiration to offset the cost. The goal is for the stock to drop to the put you are short or, in this case $74 by January expiration. That’s as much as an 8 percent drop from its current price of around $80,” reports CNBC.
The popular high-yield ETFs include significant exposure to lower quality speculative-grade debt that are at greater risk to default. For instance, JNK has a 13.8% tilt toward CCC or lower-rated debt and HYG has 8.8% in CCC-rated securities. [Bond ETF Outflows Picking Up]
“We carry a state of tempered optimism toward high yield heading into 2016. With a near certainty the Fed commences liftoff in mid-December there is an underlying nervousness about the uncertain consequences for currencies, treasury yields, equities, and capital markets,” said JPMorgan in a note posted by Amey Stone of Barron’s.
Last week, Third Avenue Management LLC blocked investors from redeeming positions from the $789 million Third Avenue Focused Credit Fund (TFCIX), warning investors that sellers may not receive all their money back for months, the Wall Street Journal reported. The fund provider contends that the poor bond-market trading conditions made it nearly impossible to raise the necessary cash to meet redemptions without resorting to a fire sale.
“As the drop in high-yield, or junk, bonds, claimed its biggest victim since the 2008 financial crisis, BlackRock‘s Peter Fisher said Monday he does not see the risky end of the corporate fixed income market sinking the overall U.S. economy like the bust in subprime mortgages did during the Great Recession,” reports CNBC.
iShares iBoxx $ High Yield Corporate Bond ETF
Tom Lydon’s clients own shares of HYG and JNK.