Dealers in the loan-only credit default swap market suggest the ability to place a credit option on LCDS will develop in 2007. It is anticipated this could really pick up once the index, LCDX, develops. Some dealers had hoped the index would be ready by the end of the first quarter, but now it looks like it could be sometime in April or May.
Options can trade on single-name unsecured CDS, but they are illiquid. Options on CDS indices are common, and as one dealer explained, "There's no reason that we won't have options on the LCDX that trade once [that] index is trading as well."
LCDX is expected to consist of 100 names and be actively traded and highly liquid. The International Swaps and Derivatives Association continues to meet to discuss the product, which will be cash settled, unlike the single-name product, which is physically settled. A call to an ISDA spokeswoman was not returned by press time.
One dealer said a question about the development of an LCDS options market could be a lack of spread history used to calculate volatility to base judgments on. "It is a key component lacking in this market," he said. "Pricing options on LCDS may be difficult due to the lack of spread history."
