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.

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