iShares Ultra Short-Term Bond ETF: Why Cash Is Better Than Put Options

Thesis

The iShares Ultra Short-Term Bond ETF (BATS:ICSH) is a short-term bond vehicle. Given its investment grade holdings profile and ultra short duration (more than 30% of the fund has a maturity date sub 7 days), the vehicle is an appropriate cash parking tool for a mild recessionary environment. The stock market in 2022 has been nothing short of astounding when accounting for its volatility:

We can see from the above table, courtesy of Compound Advisors, that 2022 has exhibited the largest down volatility since 2009. This is far from normal, and speaks volumes to the viciousness of the bear market. Up, and range bound markets experience low volatility profiles. Bear markets on the other hand see-saw without cessation until investors ultimately capitulate. Let us just have a look at the past 5 days:

It has been nothing short of astounding what happened after the CPI report printed. The market opened much lower with retail shorting on the open. A vicious short covering rally followed that forced sellers to move back to neutral, which resulted in an intra-day swing of more than 4%! Oh, and yes the CPI print was poor, meaning inflation is still raging and rates will need to rise further.

What is a retail investor to do in this environment? Even if you knew the CPI print in advance you would have lost money on Thursday ! These are not normal times, and the short term trading patterns are driven by algos and day-traders. Buy and hold investors would do well to just stay neutral and follow the trend. The trend is down, with the market yet to bottom. In the interim we will have an enormous amount of volatility with aggressive bear market rallies.

The best solution for buy and hold investors in this environment is to cut risk as much as possible and turn the portfolio neutral by moving their cash into cash-like vehicles such as ICSH. Buying puts has proven to be a very tricky endeavor in 2022:

When volatility is high, options are expensive. Expensive options suffer from a high time decay – i.e. if the market does not sell-off as much as needed by the option expiry, investors can lose all bought premiums. This is exactly the reason for the current volatility – people buying puts and then unwinding them en masse during bear market rallies.

We are of the opinion that a significant amount of capital from very volatile corners of the capital markets, such as crypto, has now shifted into the wider equity markets. The propensity for individual investors to take very short term positions utilizing leverage is now higher. In our opinion this is another factor that has served to dial up volatility in 2022, and represents the complete opposite of a classic buy-and-hold investor.

Holdings

The fund holds only investment grade bonds:

The vehicle is overweight commercial paper:

What is more important, the maturity profile of the underlying assets is extremely short:

We can see that over 31% of the fund has a maturity date of less than 7 days. Even more importantly more than 45% of the fund has a tenor of less than 30 days. This maturity profile results in the fund’s extremely short duration of only 0.4 years:

A very short duration equates a very small sensitivity to interest rate changes. As rates move up the fund is set to have a very stable NAV. We can also notice that he very short maturity profile of the underlying collateral has resulted in the 30-day SEC yield to be quite high at 3.23%, following closely the front end of the yield curve.

All the ingredients are in place for the fund to do what a retail investor should look for: exhibit a stable NAV and offer attractive short term yields commensurate with the front end of the yield curve.

Conclusion

ICSH is an appropriate portfolio composition tool for the 2022 market. Being neutral via cash like vehicles that now yield in excess of 3% is the trade to be had. Buying options is a very expensive endeavor given the high implied volatility and aggressive bear market rallies. Buy and hold investors are best served by cutting as much risk as possible from their portfolios and keeping the proceeds in NAV stable vehicles such as ICSH.