From index futures and ETF options to total return swaps, many of the largest and most liquid equity exchange-traded funds are supported by a swath of derivatives and a ready market for borrowing ETF shares. These features allow market makers to hedge risk with precision, investors to buy or sell protection, and speculators to leverage their exposures.
Now, a similar ecosystem for fixed-income ETFs is rapidly emerging, thanks to a flood of assets and an overt endorsement of ETFs by their inclusion in the Federal Reserve's Secondary Market Corporate Credit Facility.
"Treasuries are supported by a liquid futures and options market, but when it comes to corporate bonds, trading options on ETFs may be the most effective," said Matt Berger, principal and global head of fixed income and commodities at Jane Street Group LLC, New York, one of the largest ETF liquidity providers. "This spring, the Fed's inclusion of corporate bond ETFs in its buying program was a strong signal."
By October, U.S. fixed-income ETFs topped $1 trillion in assets under management for the first time, sitting at $1.02 trillion as of Nov. 16, after having closed 2019 at $814 billion, according to CFRA's First Bridge ETF database. Net flows to fixed-income ETFs has topped $180 billion this year. At the same time, the market for options has grown exponentially.
Since February 2013, volume on fixed-income ETF options has experienced an annualized growth rate of 41%, about four times as fast as volume growth on equity ETF options, according to Joe Becker, financial risk management portfolio strategist at Milliman in Chicago.
"Fixed-income options markets have been bolstered by the development of the bond ETF market. Before bond ETFs became popular, there had not been significant options markets on leading fixed-income indices," Mr. Becker said.