The ETF AngleIn January I took a look at using bond futures and their options as speculative, hedging tools regarding the direction of interest rates. At the time, the 10-year was trading at 4.05%, but the June futures price reflected a yield of 4.50%, as the consensus opinion was that rates would be climbing over the next six months. Aside from showing just how wrong the futures market can be, it also highlighted one of the difficulties of using futures to hedge a cash position. Now I'd like to present a relatively new product that I think offers an efficient and cost-effective alternative for hedging a bond portfolio -- exchange-traded funds based on bond indices. Barclays brought out the first batch in August 2002, offering three Treasury funds: iShares Lehman 1 to 3 Year Treasury Bond Fund ( SHY), iShares Lehman 7 to 10 Year Treasury Bond Fund ( IEF) and iShares Lehman 20+ Year Treasury Bond Fund ( TLT). On April 28, options became available on all three of these ETFs.
|Interest and Bonds |
This ETF has drawn investor dollars
That rate compares favorably to the nearly 12% annual cost of protecting a stock portfolio through the purchase of S&P 500 Depositary Receipts ( SPY) put options. For a review of how these calculations were made, please see this previous article on hedging strategies. Be aware that these products have low trading volume and nearly nonexistent open interest. The above-mentioned December 89 put has just 125 contracts open. I assume this lack of liquidity is mainly due to the fact that the options began trading less than three weeks ago, and I suspect we'll see higher volumes as more investors become interested. But in the meantime, approach these options with caution.