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Monday, December 12, 2011

Trading Bonds (Part II)

Source: Capital Pixel
Yesterday we looked at the idea of bond trading on the basis of yield spreads.  Underlying this idea is that there is so-called "reversion to the mean" when it comes to yield spreads.

We looked at a set of data showing that, on average, selling IEF (a 7 - 10 Treasury ETF) and buying HYG ( a high yield ETF) resulted in a take out of $10.42.

Today HYG is $87.26 and IEF is $104.43 for a take out of $17.17! In other words, HYG is much cheaper relative to IEF than it has been on average.

This can also be expressed in terms of yield.  At $87.26, HYG is yielding 7.97%; and, at $104.43, IEF is yielding 2.69%.  The pickup in yield by moving IEF to HYG is, therefore, 5.28% (7.97 - 2.69).

Hopefully, this gives some insights into how bond traders shift among sectors of the bond market.  My plan is to revisit this trade in a couple of months to see how it works out!

Disclosure:  The information here is for educational purposes.  I hold HYG and IEF in client accounts.

1 comment:

  1. Do revisit it. This is a great case study. While I never really thought of myself as a bond investor, this has increasingly become a part of my portfolio, significantly more than what the standard age-derived recommendations would suggest. I love hearing your thoughts, so this request to continue this topic is a bit self-serving :) I hope it brings value to your readers though.