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After the Federal Reserve elected to leave rates unchanged, in typical “Fedspeak,” Chair Jerome Powell waffled between all but declaring victory on inflation while simultaneously suggesting further rate hikes remain possible. The market got the message loud and clear though: mission accomplished. We will review a bond ETF that saw one of its biggest moves in its history on Wednesday after Powell’s comments and show how options traders are playing it from here. The Dow Jones Industrial Average rallied to an all-time high and the S & P 500 is now less than 2% from its all-time highs of nearly 2 years ago on Wednesday. As sharp as those rallies were, an even more stunning move took place in corporate bonds. The iShares Investment Grade Corporate Bond ETT (LQD) rallied nearly 1.7% Wednesday and traded over seven times the average daily call volume. That move may not sound like much, and for a stock, it isn’t really, but for a diversified investment grade corporate bond fund it is huge. It is the 21st largest single-day rally for LQD since it was listed over 21 years ago, and if we exclude the wild swings associated with the Great Financial Crisis in late 2008/early 2009 and the March/April 2020 pandemic time frame it would rank as the third largest spike out of 5,195 trading days. That’s in the top 99.9th percentile. What did Powell say that got corporate bond markets so ginned up? Well, Fed chairpeople tend not to be plain-spoken about things, and generally try to bob, weave, obfuscate, and generally confuse their audience using “Fedspeak”. “Fedspeak” is the cautious, technical, and vague language popularized during Alan Greenspan’s tenure as Federal Reserve chairman a style adopted by subsequent Fed chairs. Fedspeak allows the Federal Reserve to avoid committing to a specific course of action and tends to focus on managing expectations and risks, rather than making bold or precise predictions about future policy actions. Theoretically, Fedspeak is also crafted to simultaneously appear transparent, without really conveying meaningful information that might contribute to market volatility. But we experienced a more than 3 standard deviation move in the corporate bond market Wednesday. So regardless of what Chairman Powell said, the market heard what it wanted to – “We conquered inflation without tanking the economy…we achieved the soft landing!” In other words, mission accomplished. What options traders are doing The fall in rates naturally propelled bond prices, which move in the opposite direction, higher. That helped bolster LQD, but the other instruments have more “duration” (interest rate sensitivity) than LQD does, such as the long-term treasury bond ETF — TLT . So if rates alone don’t account for the sharp spike, what else did? Credit spreads refer to the spread between the higher yields investors demand for riskier bonds than those they demand for less risky bonds, and those spreads narrowed to the lowest levels in nearly 2 years. Corporate bond investors see lower rates and lower risk. Whether you agree with that assessment or not, technical traders might be wondering whether the steep downtrend that led to the largest decline in the fund, nearly 30% from the 2020 peak to recent lows, may finally be reversing, and if it does betting it could still have room to run even after today’s remarkable rally. How far could it go? One trader purchased 1,000 February 110 calls for a price of $1.60, or just under 1.5% of LQD’s closing price of 109.75. The buyer of those calls is betting LQD could rally more than another 1.7% between now and February expiration. Wait, risking less than 1.5% of the share price to make a bet that LQD could rally as much over the next two months as it did Wednesday alone? That’s the interesting thing about a bond fund that doesn’t typically move very much. Options premiums are generally quite low. Also since a holder of call options does not get the dividends the ETF shares themselves pay as the fund collects coupons of the bonds held by the fund, that decreases the value of calls, all else equal. Still, at least one institutional trader believes this is a small amount of premium to pay betting that LQD’s rally has legs. To buy an at the money call option for less than a single-day’s (albeit exceptional) move, is indeed pretty cheap. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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