Corporate Bonds (LQD) Gets a Vote from Options Market

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October 21, 2020

LQD Unusual Option Activity Report

Investment grade bonds have been selling along side U.S. Treasuries as inflation fears are ramping up on stimulus talk. As the price of the iShares iBoxx Investment Grade Corporate Bond ETF (NYSEARCA: LQD) is testing recent support near $134.50, a large bullish option trade was made early Wednesday.

Bonds & Inflation

While the timing of when stimulus delivered is uncertain, the certainty of it happening is clear. The make-up of the spending and the size of the bill are the only variables in doubt. Oh yeah, there’s also a very willing Federal Reserve desirous to engage in an expanded QE after the election.

With that sort of back-drop, you would think that U.S. Treasury yields would be moving sky high. However, there is enough drag, for now, to suppress some degree of inflation expectations. That means that it’s unlikely that the 10-year Treasury note yield and other maturities will move significantly higher.

As U.S. Treasuries sell off and their yield rises, this places bearish pressure on investment grade debt because the risk-free rate is moving higher and risk premiums are low. The bullish activity in the option market for LQD is telling a bullish story for bond prices and a bearish story for yields.

LQD Option Activity

The put option market is definitely sizzling today. The put volume is nearly 15 times the average at the time of this writing with 99% of the volume getting filled at the bid! Virtually all of the volume occurred in three prints at the same time. Here is a breakdown of the activity:

  • 39,810 15 JAN 21 $130 put sold @ $0.90
  • 2,000 15 JAN 21 $130 put sold @ $0.90
  • 2,000 15 JAN 21 $130 put sold @ $0.90
  • 810 15 JAN 21 $130 put sold @ $0.91
  • 357 15 JAN 21 $130 put sold @ $0.94

Those five fills that occurred a little over 30 minutes into the session totaled 44.977 contracts. These are opening orders because the open interest stands at 5,367. The strike selection is a way away from the price at the moment, but the timing and the size of the activity is significant. Also, the trade is a bullish indication for bond prices.

LQD Charts

The support for LQD near $134.50 is significant. It was an area of resistance in February and mid-June. It also acted as a support multiple times in August and September. This is occurring as the 10-year U.S. Treasury note yield is testing its resistance near 0.80%. Remember that as prices move up, yields move down and vice versa. If the 10-year finds resistance at this yield, then that is bullish for LQD in the near-term.

While the selling of the put isn’t a directional trade, the potential for LQD to rally to retest its August high near $139 seems reasonable.

Conclusion

It isn’t a foregone conclusion that yields aren’t going to rise instead of fall. However, the increased amount of debt on the balance sheet of many companies exposes them to negative price pressure if yields rise too quickly. The precarious position we find ourselves in makes this trade interesting for its directional bias and its opportunity.

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