Lesson 25 of 25
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.