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Derivatives

Basis Trades Take Hold In Lackluster Market

Basis trades between cash bonds and credit-default swaps are becoming popular, safe trades given the credit markets are stuck in a frozen position.

Basis trades between cash bonds and credit-default swaps are becoming popular, safe trades given the credit markets are stuck in a frozen position. Tight spreads, the technical drive from the pipeline of constant proportion debt obligations and the sense the market may be in a non-default scenario for the next 18 months, are luring investors into the near-term, according to dealers.

Funds have been looking for credit names to differentiate in order to put down pair trades. But this has proved to be a losing strategy recently following another quarter full of strong earnings. "For a while now you have seen people trying to not throw in the towel and get married to a carry trade," said one flow trader. "But, more and more the carry trade is the trade."

The near-term driver is the basis trade because a large pipeline of cash bonds has underperformed the CDS, officials said. Although structured products cannot print at the levels marketed just weeks ago, spreads are within just a few basis points of where they can print and that has left market participants unsure of their next move.

Traders also said dedicated long/short equity funds are increasingly playing in CDS via their own carry trades, by shorting a company's stock and selling default protection on the company's debt.

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