Comments on: Chart of the day: The CDX NA IG 9 basis A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: DMW1111 Tue, 15 May 2012 13:20:39 +0000 Agree- this is all about tranches….he would struggle to lost that much in single names, but the deltas on tranches make it a lot easier

By: MrRFox Mon, 14 May 2012 13:22:13 +0000 Has anybody besides me noticed that Danny Black has been eerily quiet since about the time The Whale started taking harpoons?

You don’t suppose ….?

By: kanodra1 Sun, 13 May 2012 06:19:14 +0000 I think the trade is the Index Tranche. (IG9 has 125 original constituents, of which 4 have defaulted.) The tranche is 3%-7%. I.e. you lose money once 3% of the capital is wiped out. (i.e. say 6 names default, and recovery is 50% on each)

The biggest problem with CDOs, is the correlation between defaults is difficult to estimate or model. (i.e. if one of the underlying name defaults, how likely are the balance)
This can range from +100%, i.e. all credits in the index default together, 0%, i.e. no default is correlated with another, or -100%.
i.e. When one company defaults, all the others are surely not going to default during the balance tenor. (negative correlation happens when one company goes bust, but economy is doing very fine, and spreads on other credits tighten)

Now the basis is between the tranche, and the underlying index (not cash and CDS)

more details in this ZERO Hedge column il-trade-ig9-tranches-explained

By: ClarenceD Sat, 12 May 2012 17:23:37 +0000 Replying to my own post :)

Sorry, screwed up the side in my previous post. So, for this to work he would have almost 150bn notional sold (to get to roughly 2Bn in losses) of 10y?

By: ClarenceD Sat, 12 May 2012 17:08:50 +0000 Hedge funds were saying he was selling the 10Yr S9 and buying 5yr S9. To get a net buyer position he would have to buy up an impossible amount of the 5yr S9 to get anywhere near enough of a position for this 30bps to produce a large loss.

None of this computes, given the relatively benign moves in the indices recently. Haven’t looked at possible correlation trades, but I think that’s the only thing that might help explain it.

By: y2kurtus Sat, 12 May 2012 00:31:52 +0000 If you look at the bonds in the index JPM’s “bet” is exactly right. The lifetime credit losses (net of recoveries) on that balanced portfolio of investment grade debt will be less than 1%.

Things I don’t understand:

#1. Why would JPM close out of this trade… it’s not like they got stopped out or faced a margin call forcing their hand. 2 bil is a lot of scratch but in the context of a 2 tril balance sheet it’s not the end of the world.

#2 Who is on the other side of this trade. I’ve seen a refrence that two hedge funds run by ex-JPMers have pocketed a cool 30MM each… that’s nice money but this is a zero sum trade… where is the other 1,940,000,000?

#3 If the financial community is understanding this correctly/fully (which I doubt) then the original opportunity JPM was looking to exploit should be crazy ripe for the picking. Would not supprise me at all to see Berkshire take the risk off JPM’s hands. Pre-crisis a berkshire subsidary (Kansas Surety) use to insure bank deposits in excess of the FDIC limits for a mer 15 basis points… this trade is way jucier!

By: Will.01 Fri, 11 May 2012 19:15:28 +0000 Mr. Dynamite: thank you.

If one were to open a trade like jpm did and hold it long enough (assuming they could) would it expire worthless like an option would if it weren’t in the money?

I understand that if someon sold protection on a bond and there was no credit event the seller wouldn’t lose any money once the bond matured or was called. I don’t quite get how cash index CDSs work, obviously.

Also, is a CDS a derivative?

Thanks again from the cheap seats.

By: KidDynamite Fri, 11 May 2012 19:03:17 +0000 Will.01 – they are mark to market losses: the current value of the trade has moved against you, but you haven’t had to pay out on any of the protection that you sold yet. that’s the boat that JPM is in.

By: Will.01 Fri, 11 May 2012 18:09:41 +0000 I have a very basic question that I would be grateful if someone could answer about how CDSs work. If I sell an option and it expires out of the money, I lose nothing even if the underlying rises.

But from what I read about CDS trading, if I sell protection I can lose money if the index goes up even though no one defaults. This seems to be the case with the JPM trade.

Thanks in advance.

By: FosterBoondog Fri, 11 May 2012 17:02:18 +0000 30 bp of spread on $100 bn notional CDX is about $1.2 bn in return. That’s in the right ballpark.