Credit Derivative Trading Strategies

Basis Trades: Made based on the difference between a bond's yield and the CDS premium.

Curve Trades:

Flattener: Buy the short term CDS and sell the long term CDS

Steepener: Sell the short term CDS and buy the long term CDS

Index Trades: An investor can buy or sell a credit index

CDS Basket Trades (or Correlation Trades): Credit protection can be sold on an entire portfolio of bonds; the seller pays only for the individual issue that defaulted and the basket continues.

First to Default Baskets: seller will deliver the entire notional amount of the basket once the first default takes place.

CDS Options:

Payer Options: Provide the option holder the right to buy credit protection in the future.

Receiver Options: Provide the option holder the right to sell credit protection in the future.

Capital Structure Trades: Designed to exploit mispricings in a company's capital structure.

For example, if a trader expects a company to increase its leverage and does not feel that this has been appropriately priced in the market, then he/she may buy a CDS and buy a long stock call option (in order to make money if the stock rises).

Other capital structure trades may involve taking a long position on the CDS for one debt issue by a company and taking a short position in another debt issue by the same company.