« October 2019 »

IVolatility Trading Digest™

Volume 19 Issue 42
Hedging High Yield Bond ETF [Charts]

Hedging High Yield Bond ETF [Charts] - IVolatility Trading Digest™

As the S&P 500 Index advanced back up toward the September 19 high, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) followed higher closing in on its September 19 high, just .10 away. A partially hedged trade idea for HYG follows the Market Review.

Review NotesS&P 500 Index (SPX) 2986.20 tacked on another 15.93 points or +.54% last week closing well above the 50-day Moving Average. Until it closes back above the September 19 high at 3021.99, it remains range bound with an open pattern gap created by the gap up open on October 11. Since pattern gaps are usually filled, a decline back to support at the top of the previous range between 2825 and 2950 should do the trick, but may not happen until after SPX reaches the July 26 high at 3027.98.

Review NotesCBOE Volatility Index® (VIX) 14.25 declined 1.33 points or -8.54% last week. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, declined 1.39 points or -10.14%, to end the week at 12.32% ,vs. 13.71% week ending October 11, shown in the chart along with a small SPX line chart below.


With less China trade news and tweets, the IVXM drifts lower as SPX advances, encouraging the bulls.

VIX Futures Premium

The chart below shows as our calculation of Larry McMillan’s day-weighted average between the first and second month futures contracts.

With 22 trading days until November expiration, the day-weighted premium between November and December allocated 88% to November and 12% December for a premium of 17.76%, in green zone with a very normal curve, and better than 14.18% on October 11.


The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month futures contract converges with the VIX at expiration on Wednesday November 20. Typically, a normal upward sloping futures premium curve above VIX by 10% - 20% correlates with a rising SPX.

For daily updates, follow our end-of- day volume weighted premium version located about halfway down the home page in the Options Data Analysis section on our website.

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iShares iBoxx $ High Yield Corporate Bond ETF (HYG) 87.09 up .32 or +.37% last week.

Branded in Digest Issue 28 "Double Barrel Indicator [Charts]" because it includes additional information from the bond market such as credit risk and liquidity for M&A, stock buybacks, and refinancing activity makes it skewed more toward default risk and liquidity than earnings, China trade news, inflation or interest rate speculation. While useful as a confirming indicator with a better dividend yield, than the SPDR S&P 500 ETF (SPY) 297.97, it distributes dividends monthly at an annualized rate of 4.80% compared to the current annualized quarterly rate of 1.86% for SPY, while correlated .96 with SPY.


While currently below and tracking the operative upward sloping trendline, USTL in the chart above, a close back above the September 19 high at 87.19 will create a new USTL from the December 26 low. In the event of a decline, the 50-day Moving Average (blue line) should provide the first support, followed by the previous highs around 86 marked with the dotted green line as the second support. BlackRock, the manager, reports the effective duration, or sensitivity to small interest rate changes, as 2.88 years, down from about four years in July. Subtracting the yield on the three-year Treasury note of 1.56%, from the 30-day SEC yield of 4.90%, represents the credit risk portion of the total yield at 3.34%.

News that the Federal Reserve started buying $60 billion per month of Treasury bills on October 15 and will continue adding cash into overnight lending markets along with a possible change in bank cash reserve requirements should reduce concerns about a year-end liquidity squeeze thereby improving sentiment enough to suggest a new hedged long. Using Friday's prices consider this idea.

Long 100 shares of HYG at 87.09

Partially hedged with a put spread.

With a current Historical Volatility of 3.76 and 2.77 using the Parkinson's range method, the Implied Volatility Index Mean is 5.44 at .08 of its 52-week range, but the implied volatility/historical volatility ratio using the range method is 1.96 so option prices are moderately high relative to the recent movement of the ETF. Friday’s option volume was 206,068 contracts with the 5-day average of 175,070 contracts with reasonable bid/ask spreads.

Almost no premium for out-of-the-money calls eliminates using a low cost collar (long an out-of-the-money put and short an out-of-the money call). However, a long put spread should provide some down side protection.


Using the ask price for the buy and mid for the sell the debit was .41 with good implied volatility edge, meaning the call sold (6.98) is relatively more expensive in implied volatility terms than the long put (4.65).

The next dividend on November 1 covers a good portion of the hedge cost presuming it equals the October dividend of .35. One put spread will hedge only about one-half of the risk, so plan to sell 100 HYG should it close back below the green support line at 86 and then wait for HYG to decline further and make a pivot before closing the put spread. On the upside, use a close back above the September 19 high at 87.19 as the SU (stop/unwind) for the put spread.


The caution and hedge images that began appearing in the Strategy section of Digest Issue 32 "Option Spreads [Charts]"on August 12, 2019 now seem less important so they have been removed, but will likely reappear when SPX again makes new highs.

Although earnings reports should receive the most attention this week, China trade news and rotation out of former leaders can still cause sudden problems for the bulls. However, the announcement from the Federal Reserve on October 11 to start buying Treasury bills and injecting cash into the overnight bank lending market seems designed to keep the yield curve under control and reduce liquidity anxiety.


Last week, with less China trade news and fewer tweets, the markets focused more on earnings releases and the S&P 500 Index responded positively, moving back up toward two previous highs it will need to overcome and turn the bulls loose again. Supported by the Federal Reserve's announcement to start buying Treasury bills and injecting cash into the overnight bank lending market reduces the need for hedging long positions. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) with a higher yield makes an attractive alternative to the SPDR S&P 500 ETF (SPY).

Actionable Options™

We now offer daily trading ideas from our RT Options Scanner before the close in the IVolatility News section of our home page based upon active calls and puts with increasing implied volatility and volume.

“The best volatility charts in the business.”

Next week expect another Market Review along with a report on the progress of the HYG trade idea.

Finding Previous Issues and Our Reader Response Request


All previous issues of the Digest can be found by using the small calendar at the top right of the first page of any Digest Issue. Click on any underlined date to see the selected issue. Another source is the Table of Contents link found in the lower right side of the IVolatility Trading Digest section on our website homepage.

CommentAs always, we encourage you to let us know what you think about how we are doing and what you would like to see in future issues. Send us your questions or comments, or if you would like us to look at a specific stock, ETF or futures contract, let us know at Support@IVolatility.com or use the blog response at the bottom of the IVolatility Trading Digest™ page on the IVolatility.com website. To receive the Digest by e-mail let us know at Support@IVolatility.com

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IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter constitutes a recommendation to buy or sell any security. Before entering a position check to see how prices compare to those used in the digest, as the prices are likely to change on the next trading day. Our personnel or independent contractors may own positions and/or trade in the securities mentioned. We are not compensated in any way for publishing information about companies in the digest. Make sure to due your fundamental and technical analysis homework along with a realistic evaluation of position size before considering a commitment.

Our purpose is to offer some ideas that will help you make money using IVolatility. We will also use some other tools that are easily available with an Internet connection. Not a lot of complicated math formulas but good trade management. In addition to Volatility we use fundamental and technical analysis tools to increase the probability of success and reduce risk. We prepare a written trade plan defining why the trade is being made, what we call the "DR" (determining rationale) and the Stop/unwind, called the "SU".