Anyone who had almost any type of investment in a bond last year learned about how the values are not always as dependable as one might hope.  Yes, if you hold a bond for the entire duration, there is no interest rate risk related to that specific bond.  However, you still can see a value go higher or lower during the duration.

I wanted to write this piece to talk about a strategy that not a lot of people have the desire to employ.  That is buying puts to protect your bond holdings. 

Before you stop reading or go and grab the toothpicks to keep your eyelids open, let me tell you, 2022 was a year that made this strategy a lot more relevant.  With the drops we had in bond values (treasuries, corporates, and municipals), it may be something to consider going forward.

What I want to highlight in this article is that you can hedge certain bonds just as easily as you can a stock.  For example, let’s take a look at IEF, TLT, and LQD.  There are others, but these are the 3 we will look at today.  They all are optionable ETF’s that trade various bonds.  In my opinion, TLT is the one that has the easiest tradeable options.  However, it moves the most as it is an ETF that holds longer term treasuries.  In other words, “this aint no CD”.  IEF and LQD are not great choices if you want to do a lot of frequent buying and selling of options, but for selling calls and letting them expire worthless, or buying longer term puts as a hedge, they do function pretty well in my opinion.

As said above, TLT is an ETF that holds US government treasuries.  Their typical duration is greater than 20 years.  Because of the longer term duration, there is typically more movement in the pricing (for better or worse).  In times when we are not in an inverse yield curve, TLT will pay the most interest of these ETFs as it has a longer duration.

LQD is a corporate bond ETF.  It typically holds investment grade corporate bonds.  If you want that exposure, you can get it here.  It also has options you can use for covered calls or protective puts.  If you are concerned about interest rate risk again in 2023, you have those tools available.

IEF is the final one that we are looking at today.  It is an ETF that holds U.S. government treasuries with a duration of 7-10 years.  It also has options.  It is kind of in the middle with regard to duration.  It is not too short term, but it is not too long term either. 

What I like about these ETF’s is that they can give you some type of bond exposure, but you can also use them to protect downside risk with put options if you so desire.  By doing that, you will make your portfolio much safer from significant downside bond risk. 

If you have any questions, please email me at mtosaw@rcmfs.com.