iShares iBoxx $ High Yid Corp Bond (ETF) (HYG), the popular junk bond ETF, has certainly put in an impressive rally over the past few weeks.
After making a low of $75.09 on Feb. 11, HYG has shot up nearly 7% over the past 17 trading days. HYG has closed higher 14 out of those 17 days as well, highlighting the magnitude of the rally.
But the rally has come too far. too fast in my opinion, and I look for HYG to have trouble moving appreciably higher over the next several weeks.
Click to Enlarge The junk bond ETF has run into major resistance at the $81 level, as seen in the chart. HYG is also overbought on a 9-day RSI basis, reaching a reading well above the 70 level before finally stalling out yesterday.
The price action from yesterday also points to exhaustion, with HYG opening near the highs of the day only to close near the lows.
According to Bloomberg News, HYG has seen record inflows recently, which is a contrarian bearish indicator. With 14% of the junk bond ETF being comprised by oil companies, any further rally in HYG is likely predicated on a continuation of the rally in oil.
Click to Enlarge Oil is facing the same sort of technical resistance as junk bonds, with the two being highly correlated.
With implied volatility near the lowest levels of the year, I favor long volatility strategies to position for a pullback. Low levels of IV are also a good contrary indicator as well, reinforcing the bearish case.
I look for HYG to retrace some of the recent rally, with a move towards the $79.30 support level the first objective. To best position for this anticipated move, a put calendar spread makes sense.
HYG Trade
Specifically, I would buy the HYG April $79 puts and sell the HYG March $79 puts for a 70-cent net credit. These are both the regular monthly expiration options. The maximum risk on the trade is $70 per spread, with the maximum profit realized if HYG closes near $79 at March expiration.
HYG also has weekly options, which would allow additional short term sales against the long position after March expiration to further hedge the position.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
