Collateralized debt obligation structurers are for the first time planning to offer investors the right to buy or sell single-tranche deals in the future. The transactions would allow investors who expect the increasingly narrow spreads on CDO liabilities will widen to come to pricing terms with originators now. At the same time, investors can earn additional fee income from the premium a bank pays for the right to complete the transaction within a three- or six-month span. Dealers such as J.P. Morgan Securities, Deutsche Bank and BNP Paribas are among those starting to price options and offer them to investors.
Michael Fuhrman, a market specialist in credit derivatives at broker GFI in New York, says the structures are attractive for alternative investors. "What does a hedge fund like better than leverage? Infinite leverage," he says. In one example, selling an option would allow CDO investors that expect wider spreads to earn income on the premium and at the same time invest their cash in other assets, according to Peter Linott, head of structuring and execution on the credit hybrids trading team at J.P. Morgan in London. Any widening in spreads would presumably be offset by the fee income they earn. The cost of the option would be based on the amount of a deal's principal and the length of the option.
Scott Eaton, co-head at Winchester Capital Principal Finance, a Deutsche Bank-seeded structured credit hedge fund in New York, says the fund would be interested in participating in these option trades as a way to express its views on spreads.
Originators say that CDOs of investment-grade corporate debt are likely to be the first ones to include the options, since deals backed by structured finance are more complex.
