Stock Options Surge as Hedge of Choice for Cornered Junk Owners

  • Contracts protecting against losses in ETF see demand jump
  • Scramble follows Third Avenue credit fund withdrawal freeze

Traders trying to stanch losses in high-yield credit are pouring into options on the largest exchange-traded fund tracking the space.

By 1:50 p.m. New York time, more than 430,000 bearish options on the iShares iBoxx $ High Yield Corporate Bond ETF had changed hands, according to data compiled by Bloomberg. That’s a record and nine times the 20-day average of 48,000. About 280,000 puts were traded yesterday.

The rush for protection comes as levels of anxiety in the junk bond market jumped after Third Avenue Management LLC froze withdrawals from a credit fund. The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, rose 36 basis points to 514.52 basis points, the highest since December 2012.

“Both speculators and hedgers are scrambling to position for further downside in the high yield markets as commodity-based equities hit fresh lows,” said Alex Kosoglyadov, vice president of equity derivatives at BMO Capital Markets Corp. in New York.

Global equities tumbled Friday, with the U.S. stock benchmark sinking more than 1.5 percent. Commodities led declines as oil plunged to a six-year low and a rout in metals prices worsened.

Trading in the high-yield ETF options surged as billionaire investor Carl Icahn said more pain is coming. “The meltdown in High Yield is just beginning," he wrote on his verified Twitter account Friday. 

The number of calls traded on the high-yield bond ETF, known as HYG, also jumped to about 150,000, Bloomberg data show. Total volume of HYG options reached 583,000, or about one-third of all the contracts outstanding.

Volume on HYG in the two days rivaled options trading for some of the largest equity ETFs. The 20-day average volume for the iShares Russell 2000 ETF is around 480,000. It’s about 290,000 for iShares MSCI Emerging Markets ETF.

Junk bonds are poised for their first annual loss since 2008. With Federal Reserve Chair Janet Yellen poised to raise borrowing costs next week, raw material prices have slumped and defaults by the commodity industry are forecast to accelerate.

“It’s certainly possible that investors believe a 25 basis-point rate hike, as expected by most on the street, could exacerbate the issues facing commodity-based companies dependent on capital markets access,” said Kosoglyadov.

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