HY puts offer better hedge than IG payers, says Barcap

Barclays Capital says that options on the US high yield credit index may be a more efficient way to go short than payers on the investment grade index. In a recent report, the bank’s analysts note that if the stable relationship between investment grade spreads and high yield prices of the past year continues, then out-of-the-money options on the two indices should become in-the-money at about the same time in a sell-off. Furthermore the pay-off from a high yield put at expiry outperforms an IG payer.

The report says there could be various reasons for this mis-pricing, such as the higher transaction costs of the less liquid high yield options. However, as liquidity in the high yield options market develops, it may attract new buyers of volatility who want to hedge against spread widening.