Deutsche Bank is recommending clients sell five-year credit default swap protection on Royal Caribbean Cruises. On a LIBOR basis, selling protection is a better way to gain exposure to the credit than buying bonds issued by the cruise line--four-year bonds at press time were trading at around LIBOR plus 220 basis points, while five-year protection trades around 300bps. Protection is higher than it should be, because the cruise line last week issued USD500 million in convertible bonds of '21, which are putable after four years, said a trader in New York.
Convertible arbitrage players often buy default protection on convertible bonds in order to strip out credit risk, essentially leaving only interest-rate risk, which is easily hedged, and the embedded equity option. This demand is increasing the price of protection, which is usually based on the likelihood of default and trades in line with a company's regular bonds. Investors can take advantage of this increase by selling protection via the credit default swap market or a credit-linked note.
Similar situations exist for other names with outstanding convertibles, such as Tyco International, where one-year protection can be sold at 90bps, but the bonds trade at LIBOR plus 70bps, said the trader.
