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Derivatives

Index Arb Holds Interest During Sell-off

Credit traders were focused on index arbitrage last week as the CDX family of indices gave up all of the gains made this year during the market-wide sell-off Tuesday.

Credit traders were focused on index arbitrage last week as the CDX family of indices gave up all of the gains made this year during the market-wide sell-off Tuesday. The most active flows were from hedge funds looking to sell protection on the index and buy cover on the single-names it references and which had not widened so dramatically.

The investment-grade series 7 moved out five basis points, the high-yield moved out nearly 35 bps and the High Vol 11 bps, all on Tuesday. Traders reported trading volumes four times usual volumes.

"Some people were just profit-taking here, I don't think anybody really believes this is where the credit cycle turns," said one credit trader in the U.S. This view was borne out by the fact pipelines for collateralized debt obligations remain strong week to week.

Victor Consoli, strategist at Bear Stearns, recommended being a buyer of risk in High Vol 7 at 80 bps or better, and looking for bargains in autos and BB homebuilders which also widened last week. In a research report, the firm's strategists also favored five/seven steepener trades on leveraged buyout candidates, particularly those whose stock sold off last week.

Amid the index activity, traders were kept busy with investors looking to buy protection on Dow Chemical Co. The name widened over 20 bps last week to 42.5 bps at the start of last week. The widening was triggered by a report published in U.K. newspaper The Sunday Express that buyout firms Kohlberg Kravis Roberts, Blackstone Capital Partners andThe Carlyle Group are putting together a bid for the company in the region of USD54 billion.

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