CDS Option Sellers Drive Vols Down
Sellers of options on credit-default swaps--mostly hedge funds and bank prop desks--are driving CDS implied volatility lower.
Sellers of options on credit-default swaps--mostly hedge funds and bank prop desks--are driving CDS implied volatility lower. Based on the view implied vol has been trading too high since the dislocation last year and realized vol is low, traders have started selling CDS options, reversing a structural imbalance. "Investors realized there was a big difference between implied volatility and realized volatility and that there was money to be made," said Jeff Meli, director and head of U.S. structured credit strategy at Barclays Capital in New York. "It's a new year, and people are more willing to look at new products."
The increase in volatility selling coincides with a dramatic increase in overall volumes of CDS options trading. CDS options volumes have more than doubled in the last three to six months, with particular activity in the past few weeks, Meli said. While real money accounts tend to focus only on yield enhancement and downside protection, hedge funds and prop desks also use CDS options to trade credit volatility.