The fund will invest primarily in a mix of TIPS and long options tied to the shape of the interest rate yield curve (which has inverted as of today). The strategy aims to hedge against inflation risk and make money from options when interest rate volatility increases or the yield curve steepens.
The options are expected to:
- appreciate in value as the swap curve steepens or interest rate volatility increases and
- decrease in value or become worthless as the swap curve flattens or interest rate volatility declines.
Well, a swap curve shows the difference between swap rates (i.e., the fixed interest rate exchanged for a floating interest rate in an interest rate swap) applicable to debt instruments with different maturities.
It is kind of like a traditional bond yield curve, "but instead of reflecting the fixed interest rates on debt instruments of specified maturities, [it] reflects the fixed interest rates used in interest rate swap agreements related to such instruments," the prospectus says.
The swap curve gets steeper gets "steeper" when the spread between swap rates on longer-term debt instruments and shorter-term debt instruments widens and "flattens" when such spread narrows.
When the fund purchases an option, it pays a cost to purchase the option. As the fund will buy options over the counter (OTC) it may only have to pay a very small premium ‚Äî or no premium at all. As a result, the options it invests in are "generally are subject to greater credit risk," the prospectus says.
The options will also have to be rolled, as the old ones expire and new ones are bought. This may also trigger contango.