Now we are getting down to the nittty gritty. How do you access Credit Default Swap info. if you are not willing to spend 2k/month for info?
Yeah, I recall that one of the airline put buyers was actually hedging a large long position in the stock but not much else. Theoretically, yes, but in most cases they use cash bonds instead of the CDS. CDS does not carry as well due to the bond/CDS basis (which is, in essence, a cost of balance sheet) plus CDS has a delivery option that can get tricky. Usually it only makes sense in one direction, long credit and short stock via puts. Also, for maturity-married bonds and options, you can simply look at the breakeven and decide if you like them, so very little modeling is involved. PS. Some of these trades looked pretty f*cking good in March before the Fed bought all bonds and stopped the party.
Not sure, there might be some free resources out there. In any case, you can proxy it by looking at corporate yield minus the treasury yield. You'll be off a little because of the bond/CDS basis but you'd be close enough.
Thank you for claryfing that. I didn't understand the comment about the CDS not carrying well, can you expand on that? How does the bond/CDS basis impact the attractivness to trade it. Do someone else besides quants trade these arbitrage opportunities? I remember reading about the Long/Short Plays with Credit/Equity in the book Quants as one strategy they frequently used to trade. Are these opportunities even an option for fundamental traders?
I think I get what you are saying. Price the Default Risk via BSM, then price the Bond->if it's underpriced, go Long Bond and Short Stock. This strategy must be delta neutral (Interest/market/Industry/Business risk eliminated) then and played with Options that have a long Maturity (Maturity married? So this can only be played with 2-3 year bonds max?). What about Volatility? Is the Volatility increase usually enough to compensate for the increase in Asset Volatility/Bond Value decrease? Or do you hedge out Volatility risk here? Probably not right? Since Asset Volatility is solved based on long term historical Volatility, so one might even have an edge this way, if you attempt this strategy when volatility is low. These Opportunities in March, are those usually around, even when quants scan the markets? Really enjoy reading your posts mate
Credit funds are hedge funds that focus on credit. It's a diverse set of strategies, some people do distressed investments and restructuring, some people trade single name, some people look at structured deals etc. The broad theme is the the companies access to leverage, be it loans, bonds etc. In case of the capital structure arbitrage, they try to find inconsistencies between different leverage "slices" of the company - such as equity vs debt, preferred equity vs debt etc. In the simplest form, where you happen to have stock options and bonds maturing roughly at the same time, you don't even need to bother with default probabilities. If you actually want to use the probability of default, the logic goes roughly as follows: (1- P) * (par + cpn*N - bond_price) + P * (recovery - bond_price) = bond_leg P * (strike - premium) - (1 - P) * premium = put_leg but you can just as well break it into two outcomes: default = (recovery - bond_price) - premium + strike survive = (par + cpn*N - bond_price) - premium Anyway, it's a strategy with a lot of moving parts and very execution sensitive, so takes a lot of tinkering to get it working. Some but not as obvious or big (capacity-wise) as in March, but yeah, you can find opportunities in less liquid names in regular markets.