U.S. Markets close in 4 hrs 57 mins

Massive upside trade in junk bonds

David Russell (david.russell@optionmonster.com)

One big investor is looking for junk bonds to stay strong next year even with interest rates pushing higher.

optionMONSTER's Heat Seeker monitoring program detected a massive three-way bullish trade in the iShares iBoxx High-Yield Corporate Bond exchange-traded fund. It involved the purchase of 13,000 March 94 calls for $0.45 and the sale of equal amounts of March 90 puts for $0.90 and March 95 calls for $0.10. Volume exceeded open interest at all three strikes.

The trader collects a credit of $0.55 and stands to earn an additional $1 if the fund closes at or above $95 on expiration. They're on the hook to buy it on a drop to $90 because of the short puts , and they'll start losing money under $89.45. (See our Education section)

The HYG is off 0.11 percent to $92.95 in afternoon trading. The fund declined sharply in May and June as investors worried about rising interest rates, but it has slowly worked its way higher since.

The Federal Reserve finally resolved some of those fears this week by slowing the pace of its fixed-income bond purchases. Nonetheless, junk bonds are closely correlated to equity prices, so the same improving economy that allowed the Fed to taper could also support high yield.

It's also noteworthy that puts are much more expensive in the HYG than calls because it's prone to fall after monthly dividends are paid. Selling them lets the investor profit from the fund's rich payouts without ever owning it directly.

Total option volume was quadruple the daily average, according to the Heat Seeker.

More From optionMONSTER