How High Yield Bonds Protect Downside Losses

High yield bonds are fixed income instruments issued by companies of lower quality credit than “investment grade”. They are sometimes known unfortunately as "junk bonds". I feel this is a misnomer, as such instruments have a rule to play in financing companies, just the same way as issuing stock to a smaller, lesser known company might play.

As the name suggests, high-yield bonds have an interest rate, or “yield”, that is higher in general than government bonds and higher-quality corporate bond instruments. Current ranges I see are from about 6% to 12%, with the higher end of that range typically being bonds purchased on margin. This presents an added risk of additional downside losses in the event that such bonds lose value.

In my strategies, high-yield bonds are used to replace the cost of calls and/or puts taken to create the strategic positioning for the investor. The positions are designed such that, if the amount spent on calls or puts is completely lost due to the market being flat or down at expiration of the contract, the interest earned on the high-yield bond fund from the time of purchase of the options replaces most or all of that cost. As such most or all of the original principal is returned to the investor in the event the investment is flat or down between purchase and expiration.

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