JPMorgan, Merrill Lynch and Deutsche Bank are among credit houses making inroads into the budding tranchelets market by quoting two-way prices for the instruments. Tranchelets are very thin slices of the equity tranches in the credit derivatives indices (DW, 1/6).
Dirk Muench, credit derivates analyst at JPMorgan in London, said, "It's a need of JPMorgan and the wider market to improve risk management of CDOS, especially in the first-loss piece," he said. A trader added, "They are a very, very hot topic." The instruments present opportunities for higher yield because of higher leverage and risk, as well as relative-value plays and option-like trades on default rates, he added.
Mickey Bhatia, director and head of flow correlation trading at Deutsche Bank in London, said his firm is trading an average of four CDX tranchelets a week with notionals of between USD5 and USD10 million. He also noted a number of inter-dealer plays. Dealers at Credit Suisse First Boston, Morgan Stanley, Citigroup are also considering or already trading tranchelets.
Olivier Renault, credit strategist at Citigroup in London, said a liquid tranchelets market may not develop until observable implied correlation points for tranches below 3% materialize. Another strategist agreed, saying there are price discrepancies between dealers who have different default-rate assumptions. "At the moment it's the gut feeling of the trader," he noted.
