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Derivatives

Investors Examine Equity Tranche Correlation Plays

Investors are beginning to look at trades which will capitalize on a U-shaped equity correlation term structure in the CDX and iTraxx credit indices.

Investors are beginning to look at trades which will capitalize on a U-shaped equity correlation term structure in the CDX and iTraxx credit indices. The U-shape formed when high volumes of bespoke CDO issuance pushed up correlation (DW, 12/12). Five- and 10-year correlation has widened to 13.5% and 12% respectively, while five-year tightened to below 11%, traders said. Strategists are suggesting trades to profit from out-of-kilter correlation, such as going long seven-year and short five-year. This is especially effective in off-the-run indices which are less subject to current auto volatility.

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