Long-term buyers of credit protection are expected to suffer more pain next year as spreads on default swaps and bonds stay tight. Michael Cloherty, market strategist at Credit Suisse First Boston in New York, said that while buyers of long-term protection suffered from the rally this year credit volatility worked to reduce some of the pain.
Next year, however, no near-term triggers are anticipated that will provoke overall spread widening for several earnings seasons. Holding short credit positions with a negative carry through this period will be difficult, noted Cloherty.
To offset this exposure protection buyers should overlay their positions with alternatives such as selling protection on baskets of swaps or taking a long position in equity, said Cloherty. This allows traders to adopt a positive or flat carry position until spread widening allows investors to profit from the trades, he added.
