Players have started shorting the ABX for the first time, prompted by unexpected spread widening and uncertainty surrounding the first roll of the residential mortgage-backed securities index. While basis trading of the index versus single names is boosting ABX liquidity and offering profit-taking opportunities to hedge funds, dealers warn these may be short-lived.
The opportunity was created by widespread inflationary fears which caused a broad sell-off across markets despite strong market fundamentals. As equity indices declined last month, credit indices across the board widened. "There is no fundamental reason for markets to be correlated," said Rajiv Kamilla, v.p. in the structured products group at Goldman Sachs, at the CDO Summit in New York last week. "Correlations exist where they shouldn't because the same players are in all markets. We have seen a rapid transmission of high volatility across multiple markets because the same players are in all of them. When they feel pain in one, they unwind in others."
ABX BBB and BBB minus spreads last week traded at 143 basis points and 255 bps respectively, about 30 bps and 40 bps wide to average single-name BBB and BBB minus RMBS. "There is a view that if you want to short this [ABX 06-1] vintage you should do it now, before the index rolls," said Todd Kushman, managing director and product specialist for ABS derivatives at Bear Stearns in New York.
Kamilla pointed to the stability of single-name spreads as evidence of the market's fundamental strength and a technical explanation of the ABX widening. Kushman said single names are less volatile because traders take more specific longer-term views on them than on the index. Traders use the index in the short term to offset or hedge long-term single-name views. Until recently, players were heavily long the index and short the names. But the approach of the roll and recent macro changes have people selling the index and pairing off single-name positions, and trading the ABX like corporate indices. "Volume is picking up massively and there is more liquidity every day," Kushman said.