Options Activity in Junk Bond ETF Could be a Negative Sign

For all the chatter about outflows from high-yield bond ETFs and talk of a junk bond bubble, the marquee ETFs tracking this asset class have held up well. In fact, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE:HYG), the SPDR Barclays Capital High Yield Bond ETF (NYSE:JNK) and the PowerShares Fundamental High Yield Corporate Bond ETF (NYSE:PHB) are all within spitting distance of new highs.

However, some unusual options activity in HYG, the largest U.S. junk bond ETF, noted by Street One Financial, could be a sign a looming bearish reversal.

"This particular ETF is often seen as a risk-on' play in that it targets exposure to high yield junk bonds, so it is very possible that a bearish speculator is looking for a reversal in the high yield corporate market (note that HYG traded at a new 52 multi-year high just as recently as Wednesday of this week)," said Street One Financial President Paul Weisbruch in a note. "It is also quite reasonable that a large institutional long term holder of the ETF is hedging an underlying position in HYG via these put trades."

Whatever the case may be, traders should keep an eye on HYG. The ETF is home to over $16.4 billion in assets under management. Along with JNK, HYG is the junk bond ETF that is most widely followed, particularly in terms of gauging risk appetite and monitoring inflow/outflow data.

As Weisbruch notes, unusual options activity in HYG could merely be a case of money managers hedging long positions in the ETF as many have been attracted to the fund's yield this year.

"Yield thirsty investment managers have likely been attracted to the fund (30 Day SEC Yield of 5.58%) in 2012, as the ETF has reeled in an impressive $4.7 billion just year to date," said Weisbruch.

In terms of establishing outright bearish bets on junk bonds using ETFs, there is the relatively unknown ProShares Short High Yield (NYSE:SJB). SJB is an inverse, but not leveraged play on HYG. Many professional traders prefer shorting JNK directly because that ETF has a higher tracking error than HYG. Tracking error is an index fund's returns and the performance offered by the index tracked by that fund.

JNK's current short ratio is 3.93, according to Finviz data. That means it would take nearly 4 days for traders to cover short positions in that ETF.

For more on junk bond ETFs, click here.