By Jay Soloff,
After a couple weeks of calm markets, stocks and bonds saw an increase in volatility this week. There are couple of major market-moving issues which certainly are being closely watched by investors.
The most obvious headline item is the potential impeachment of the President by the House. Considering that the Senate will never vote to remove the President even if he is impeached, I don’t think there will be a sustained selloff due to this news.
On the other hand, the October Fed meeting (FOMC) is about a month away. And, for the first time in a while, there’s not an obvious consensus on what the Fed is going to do (according to the futures market). There is nearly an equal probability between the Fed doing nothing and cutting rates another 25 basis points.
It’s this sort of uncertainty that can create periods of volatility in the market. Interest rates are typically a far bigger driver of stock prices than most political news items. Nevertheless, when you start mixing political uncertainty with economic uncertainty, it can be a recipe for a period of higher volatility.
Speaking of rates, given the political noise, Fed uncertainty, and concerns over an impending recession, how is the high yield bond market reacting? Keep in mind, high yield bonds are riskier assets than government bonds, but generally not as risky as stocks. They make for interesting indicators of investor concern.
The most popular instrument for trading the high yield bond asset class is iShares iBoxx $ High Yield Corporate Bond ETF(HYG). HYG also tends to have a very active options market.
Lately, HYG has been holding strong above $87, near its 52-week highs. Recent volatility and economic concerns don’t seem to be impacting HYG investors just yet. So what do the options say?
Well, at least one very large trader also appears to be quite bullish on HYG (and likely on high yield bonds in general). This trader purchased 10,000 HYG 87 calls expiring in December for $0.81 per option. Because the stock was at $87.33, these options are considered in-the-money.
Buying in-the-money options is certainly a very bullish play on an underlying asset. Although it’s a safer play from a probability standpoint than buying out-of-the-money options, the trader also has to spend a lot more on premium.
In this case, the trader is spending $810,000 in premium to purchase these calls. The breakeven point is $87.81, while max loss is the total premium paid if HYG closes below $87 at expiration. The position can generate $1 million in profit per dollar above the breakeven point.
While we don’t know for certain what the goal of this trader is, it certainly appears to be a bullish trade on high yield bonds. Perhaps the call buyer feels there’s more opportunity in high yield bonds than stocks. Or maybe the trader feels government bonds have run their course and HYG has more upside. Regardless, this is an easy trade to make yourself if you are bullish on this asset class.
This post was sponsored by Tim Plaehn, expert on income investing and a friend & colleague of mine at Investors Alley as well as a contributor here on SeekingAlpha. Tim runs the Dividend Hunter newsletter which offers a solid & diverse selection of attractive high yield plays. The service now has 9,000 active subscribers and can be had HERE for the rock bottom price of $49 (It usually is $99) for the first year. There are few better bargains around for those looking for solid income plays to balance their high beta holdings especially when equities get volatile!