13.08.201406:31:43UTC+00Investors brace for junk bonds losses

Traders of options in the US are scooping up bearish puts to prepare for incoming losses from junk bonds.

The demand for a safety precaution has pushed up the ratio of outstanding puts on the exchange traded fund (ETF) iShares iBoxx $ High Yield Corporate Bond to 5 per call. The ratio was only at 1.6 during the beginning of the year. Among the bearish contracts listed under the fund were the top eight in ownership. Puts are commonly used to hedge against a decline in the ETF since their value increases when the fund drops.

Sentiments on the market have started to turn pessimistic behind the view that the five year bull run for junk bonds may be on its last legs especially when increased demand for safer assets borne from the unrest in the Middle East and Eastern Europe is taken into account. Conflict around the world has helped spark a withdrawal in the amount of $7.1 billion from high yielding funds in the week that ended on August 6th. Lipper data shows that the net outflow for this year has now reached $9.75 billion.

Speculation on the 2015 timing for the Federal Reserve’s rate hikes is also fueling the buying spree for puts. Federal Bank of Richmond president Jeffrey Lacker says that investors should be careful to not underestimate the pace of interest rate increases over the next two years. Extra yield needed to persuade investors to purchase high risk company bonds over government debt has increased by 59 basis points since the end of June to 412 basis points at the start of this week.