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On Tuesday, Fitch downgraded J.C. Penney's (NYSE:JCP) senior unsecured notes (as well as its Issuer Default Rating) to junk territory, sending them from BBB- to BB+. Given that many retail investors venturing into the world of corporate bonds do so through exchange-traded products, holders of HYG, JNK, and PHB might be wondering how much of a negative impact this downgrade had on their portfolio. The answer: None.

As of the most recently available data, HYG and JNK held no J.C. Penney debt. On the other hand, PHB has slightly over 1% of its portfolio in J.C. Penney debt. However, despite the fact that the stock dropped more than 3.12% on the day of the downgrade, the bond market largely yawned at this news. Moody's and S&P already had the company rated Ba1/BB+ respectively, and Fitch brought its rating in line with its more influential cousins.

Investors interested in looking for the bond market's reaction to surprising news can often find the highest volatility in prices by looking at longer-dated bonds. In J.C. Penney's case, the April 1, 2037 maturing, 7.40% coupon senior unsecured note (CUSIP: 708160BS4) can serve as a good example. This $400 million issue ($325.631 million outstanding) has largely done nothing over the past year, spending most of its time trading between 95 and 100 cents on the dollar. A few excursions down to the 90 cent range during the second half of 2011 and January 2012 were exceptions.

In the days just prior to the downgrade, this note traded between 95.52 and 101.85 (dating back to February 8, 2012). On February 21, 2012, just after the downgrade was issued, the note traded between 96.468 and 100 with one exception. A customer got a bad deal from his or her broker and sold $20,000 face value of the note (sold to the dealer) at 94.968 at the exact same second the dealer sold the $20,000 face value just purchased from the customer to another dealer for 96.468 (which was in the range the note was being bid throughout the day). In other words, had the customer had a different broker, he or she would have had the opportunity to sell the $20,000 for a few extra hundred dollars, and the low of the day on this issue would have been in the 96 cent range instead of 94.968 cents.

Investors should certainly watch the bond market for a delayed reaction to the downgrade over the coming days. However, be sure to distinguish between any pullback due to a general market pullback in high-yield debt versus a J.C. Penney specific pullback. Watching the prices of HYG, JNK, and PHB should suffice when following the high-yield market in general.

When watching J.C. Penney bonds, don't forget to keep an eye on other CUSIPs besides the one mentioned above. Two examples include CUSIPs 708130AD1 and 70816FAD5. On Tuesday, these notes had similar experiences of a "so-what?" reaction to Fitch's downgrade. In the meantime, if you are interested in shorting some part of J.C. Penney's capital structure because you think J.C. Penney's new business strategy will be a flop, investors might be better off targeting the stock rather than the debt.

Or, perhaps some combination of a long position in J.C. Penney debt with a short position in the equity via J.C. Penney puts could be constructed. Such a trade would attempt to play the spread between the downside potential of the stock versus the downside potential of the notes. When factoring in the downside potential of the notes, don't forget to include accrued interest, which will offset some of the price decline.

All in all, the stock has rallied more than 75% since its 2011 low, and given that equity investors appeared to find Fitch's news surprising, one could argue that investors at the lower end of the capital structure have perhaps been a bit too optimistic about J.C. Penney's prospects.

Source: Fitch Downgrades J.C. Penney, Bond Market Shrugs