Wednesday, October 24, 2012

High Yield Bonds (HYG) - Massive Downside Positions Accumulate in Low Credit Bond Market; A Bet on an Market Decline by Dec of this Year

HYG is trading $92.80, up 0.2% with IV30™ down 2.3%. The LIVEVOL® Pro Summary is below.


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The investment seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the iBoxx $ Liquid High Yield Index.

In English, this is a high yield bond index ETF with low credit quality and medium exposure to interest rate risk according to Morningstar.

The name came up on a high volume scan – and then it got really interesting. It has already traded nearly 500% of its daily average option volume in the first four hours. The Stats Tab and day's biggest trades snapshots are included below.

We can see three things:
1. Over 16,000 contracts have traded on daily average volume of 3,386.
2. Puts have traded on a 108:1 ratio to calls.
3. The largest trade was a put ladder – customer buying the Dec 92 puts and selling the Dec 87 and 88 puts to fund the purchase, paying a net of $0.75, done 5,000x.

In English, someone bought a huge put spread and sold one more round of lower strike puts to help fund the cost of the position. But there is so much more to this…

Let’s turn to the Options Tab, below.

Note the volume today in the green numbers to the right. Then note the open interest (OI) in each of those puts to the right of that. There is a total OI of 28,850 in those three puts alone, accounting for more than 31% of the average open interest in this name.

And… this position has been growing since Oct 1. I have included the options montage as of Oct 1 focused on those puts, below.

Note that the OI at that time for all three lines was in the range of [1748, 2674]. Now we’re looking at ranges between 8,000 and 12,000 with 5,000 more trading today, alone on each line.

The stock volume throughout all of this has remained pretty tame – today for example about 1/3 of the daily average has traded thus far. One might even call it a low stock volume day. These feel like option trades untie to stock.

Let’s turn to the Chars Tab (six months), below. The top portion is the stock price the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

On the stock side we can see the general rise over the last six months, while on the vol side we can see a general decrease. The 52 wk range in price is [$77.44, $93.56], so the ETF is nearing an annual high. The 52 wk range in IV30™ is [5.13%, 19.62%], putting the current IV30™ in just the 15th percentile – nearing an annual low.

So, in English, as the high yield bond market has been rising to near annual highs and the vol has been dropping, someone(s) has been making gigantic bets on a near-term downturn. It’s a limited downside side bet – that is, it’s a put ladder, but nonetheless, these are very large sizes for this name. By tomorrow, the OI in those three strikes alone could account for more than 40% of the total average OI.

In my opinion, this is a bet on a sharp market decline before year end – not just the bond market, but also the stock market, with the high yield (low credit) names leading the way.

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This is trade analysis, not a recommendation.

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