As credit spreads plumb new depths, near record lows, bond investors aren't getting paid enough for credit risk -no matter whether its Investment Grade or High Yield. We present equity linked ideas that generate yields better than bonds (7-8% for 1-year exposure) with relatively low risk. Based off exchange trade options (ETOs), these structures are better than the popular reverse-convertibles retaining full flexibility and importantly no "knock-out" risk. Sure, these will be a tad more volatile than bonds, but the yield pickup compensates for the higher volatility. The examples in this note are illustrative and bespoke strategies to match return, risk, liquidity, and tenor are all possible with the "Non-Bonds.”
“Non-Bond” FAQs
- What is the strategy? - The common strategy is a deep-in-the money (ITM) covered call strategy
- Isn't that the same as selling out of the money (OTM) Put options - In theory, due to put-call parity, it is the same strategy-BUT, ITM covered calls appear to mis-price cash returns - as such, returns are better for ITM covered calls.
- But isn’t the equity upside capped? - While we are using high growth companies as underlying instruments, this is an yield seeking structure. There is no reason why an investor cannot have exposure to these same underlyings in the "growth" part of the portfolio.
- Isn't It better to do Reverse Convertibles (RCNs/ FCNs) - While "worst-off" structures may provide a slightly higher yield due to conditional probability, the risk of these getting "knocked-out" makes FCNs/ RCNs less attractive compared to the "non-Bonds'. Additionally, the lack of flexibility and illiquidity of structured notes are added disadvantages.
- Can an investor "mix-and-match"? Of course - these are illustrative examples and any combination of underlyings, moneyness, tenor, to generate the desired combination of risk and return is very much feasible.
- How does an investor execute these - Given these are ETOs, these can be executed on most platforms, at relatively low costs.
Non-Bond 1 - AI Hyperscalers
Non-Bond 2 - Tech Ecosystem
Non-Bond 3 - Tech Challengers
Non-Bond 4 - China Tech
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