Comments on: Credit Protection Madness? http://www.aleablog.com/credit-protection-madness/ Alea Jacta Est Mon, 12 Jul 2010 20:04:31 +0000 hourly 1 http://wordpress.org/?v=3.0 By: pdfoxy http://www.aleablog.com/credit-protection-madness/#comment-2819 pdfoxy Mon, 06 Apr 2009 16:05:35 +0000 http://www.aleablog.com/?p=2869#comment-2819 Interesting theory Interesting theory

]]> By: -jck http://www.aleablog.com/credit-protection-madness/#comment-2667 -jck Tue, 17 Mar 2009 06:59:57 +0000 http://www.aleablog.com/?p=2869#comment-2667 Yes Sir, you are missing the point ;-) For the sake of simplicity, end-users means people with a net position, unhedged, while dealers means people with positions either hedged or matched. Case1: retail investors buy the CLN, that means they (retail) sold protection and it is funded, the bank bought protection and it has bonds in portfolio so the bank is "hedged" like in a basis trade, (which means it is not perfectly hedged but that's a story for another day). Case2: retail investors buy the CLN, that means they sold protection and it is funded, the bank bought protection and doesn't hold bonds so it is going to sell protection to some other end-user for ex a hedge fund, the bank position is long protection form the CLN, retail is short (funded) protection via the CLN, the bank is also short protection with some other end user, the hedge fund in this case that is obviously long protection, there is no unfunded sold protection anywhere, as the bank is hedged or matched. Yes Sir, you are missing the point ;-)
For the sake of simplicity, end-users means people with a net position, unhedged, while dealers means people with positions either hedged or matched.
Case1: retail investors buy the CLN, that means they (retail) sold protection and it is funded, the bank bought protection and it has bonds in portfolio so the bank is “hedged” like in a basis trade, (which means it is not perfectly hedged but that’s a story for another day).
Case2: retail investors buy the CLN, that means they sold protection and it is funded, the bank bought protection and doesn’t hold bonds so it is going to sell protection to some other end-user for ex a hedge fund, the bank position is long protection form the CLN, retail is short (funded) protection via the CLN, the bank is also short protection with some other end user, the hedge fund in this case that is obviously long protection, there is no unfunded sold protection anywhere, as the bank is hedged or matched.

]]> By: ACR http://www.aleablog.com/credit-protection-madness/#comment-2666 ACR Tue, 17 Mar 2009 04:57:57 +0000 http://www.aleablog.com/?p=2869#comment-2666 I'm not sure I get the distinction between "end-users" and dealers. Imagine for some weird reason there is $500bn of retail issuance of US CLNs (this would never happen - on average a retail CLN is 10-100k and these clients like a yield pickup of 5%+ which you would never get with any sovereign CDS outside of Iceland and a couple of LatAm names). Then, let's say this one dealer that has $500bn of US CDS business (let's ignore also the fact that liquidity would never support this kind of issuance) sells $500bn of US CDS protection in the street to synthetically create this CLN issuance. Let's pretend there's only one other dealer on the other side of the trade. Then, if and when US CDS widens to oh 1000bps, the dealer that sold US CDS protection is basically bust. My point is that some dealer somewhere has to sell unfunded CDS protection in that size. There's no getting around this issue. May be I'm missing your point. I’m not sure I get the distinction between “end-users” and dealers. Imagine for some weird reason there is $500bn of retail issuance of US CLNs (this would never happen – on average a retail CLN is 10-100k and these clients like a yield pickup of 5%+ which you would never get with any sovereign CDS outside of Iceland and a couple of LatAm names). Then, let’s say this one dealer that has $500bn of US CDS business (let’s ignore also the fact that liquidity would never support this kind of issuance) sells $500bn of US CDS protection in the street to synthetically create this CLN issuance. Let’s pretend there’s only one other dealer on the other side of the trade. Then, if and when US CDS widens to oh 1000bps, the dealer that sold US CDS protection is basically bust. My point is that some dealer somewhere has to sell unfunded CDS protection in that size. There’s no getting around this issue. May be I’m missing your point.

]]> By: -jck http://www.aleablog.com/credit-protection-madness/#comment-2654 -jck Sat, 14 Mar 2009 12:59:39 +0000 http://www.aleablog.com/?p=2869#comment-2654 As for most CDSs, the bulk of gross positions is held by dealers and nets out to zero or close enough to zero, what matters for systemic risk is whether the end-users protection sellers are funded or not, AIG was writing unfunded and "retail" is writing sovereign on a funded basis. I don't agree that there has to be unfunded US CDS risk, you can hedge with another CDS but you are then long+short=0 or you can hedge with a basis trade which is the way to go since the basis is negative against certain deliverables. As for most CDSs, the bulk of gross positions is held by dealers and nets out to zero or close enough to zero, what matters for systemic risk is whether the end-users protection sellers are funded or not, AIG was writing unfunded and “retail” is writing sovereign on a funded basis. I don’t agree that there has to be unfunded US CDS risk, you can hedge with another CDS but you are then long+short=0 or you can hedge with a basis trade which is the way to go since the basis is negative against certain deliverables.

]]> By: Jessie http://www.aleablog.com/credit-protection-madness/#comment-2653 Jessie Sat, 14 Mar 2009 10:36:57 +0000 http://www.aleablog.com/?p=2869#comment-2653 Interesting theory...the issue here is that by saying that all US CDS risk is funded only pushes the unfunded risk up the chain. Say an investor comes to me with $100 and says I want a USD-denominated CLN linked to US CDS risk. What do I do? I got to the market and hedge my CLN issuance by receiving $ rates and selling US CDS. Otherwise I am running naked risk. So, at the end of the day there has to be unfunded US CDS risk one way or another. More here: http://www.acredittrader.com/?p=81 Interesting theory…the issue here is that by saying that all US CDS risk is funded only pushes the unfunded risk up the chain. Say an investor comes to me with $100 and says I want a USD-denominated CLN linked to US CDS risk. What do I do? I got to the market and hedge my CLN issuance by receiving $ rates and selling US CDS. Otherwise I am running naked risk. So, at the end of the day there has to be unfunded US CDS risk one way or another.

More here:
http://www.acredittrader.com/?p=81

]]> By: CS http://www.aleablog.com/credit-protection-madness/#comment-2641 CS Wed, 11 Mar 2009 18:34:11 +0000 http://www.aleablog.com/?p=2869#comment-2641 as always thanks a lot for the blog posts..its amazing. i guess they are not fools also because even if USA does not default, the fear or increased lack of confidence will increase the value of the CDS which is basically a way to bet on fear. Now where did i read this the last time? as always thanks a lot for the blog posts..its amazing.

i guess they are not fools also because even if USA does not default, the fear or increased lack of confidence will increase the value of the CDS which is basically a way to bet on fear.
Now where did i read this the last time?

]]> By: -jck http://www.aleablog.com/credit-protection-madness/#comment-2640 -jck Wed, 11 Mar 2009 17:08:31 +0000 http://www.aleablog.com/?p=2869#comment-2640 troy: we are in agreement, for $1 of notional that lands in a structure there is a ? multiple of that traded banks to banks, I am well aware that sov clns aren't big relative to the clns market, what i was trying to say probably not very well, is that the net-net customer flow ends up in clns or other fully funded structures, unlike the aigfp cds book that was backed by hot air i.e., unfunded. troy:
we are in agreement, for $1 of notional that lands in a structure there is a ? multiple of that traded banks to banks, I am well aware that sov clns aren’t big relative to the clns market, what i was trying to say probably not very well, is that the net-net customer flow ends up in clns or other fully funded structures, unlike the aigfp cds book that was backed by hot air i.e., unfunded.

]]> By: troy http://www.aleablog.com/credit-protection-madness/#comment-2639 troy Wed, 11 Mar 2009 16:59:45 +0000 http://www.aleablog.com/?p=2869#comment-2639 Yes there is a cln market with sov cds exposure but very small compared to the cln market overall. As far as sov cds, most voluem is single name traded by banks to banks. Yes there is a cln market with sov cds exposure but very small compared to the cln market overall. As far as sov cds, most voluem is single name traded by banks to banks.

]]> By: TC http://www.aleablog.com/credit-protection-madness/#comment-2638 TC Wed, 11 Mar 2009 16:57:56 +0000 http://www.aleablog.com/?p=2869#comment-2638 I don't think many are holding these out as literal insurance on US default, rather as a "convenient way" to short a bond thought to be under pressure ala Soros' view in his January FT article, The game changer: "The second step is to understand credit default swaps and to recognise that the CDS market offers a convenient way of shorting bonds. In that market the asymmetry in risk/reward works in the opposite way to stocks. Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential." So, my guess is that ppl are trading the CDS not holding to maturity. Krugman's being unusually narrow-minded in his blog piece. Love ya work jck. I don’t think many are holding these out as literal insurance on US default, rather as a “convenient way” to short a bond thought to be under pressure ala Soros’ view in his January FT article, The game changer:

“The second step is to understand credit default swaps and to recognise that the CDS market offers a convenient way of shorting bonds. In that market the asymmetry in risk/reward works in the opposite way to stocks. Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential.”

So, my guess is that ppl are trading the CDS not holding to maturity. Krugman’s being unusually narrow-minded in his blog piece.

Love ya work jck.

]]> By: -jck http://www.aleablog.com/credit-protection-madness/#comment-2637 -jck Wed, 11 Mar 2009 15:18:11 +0000 http://www.aleablog.com/?p=2869#comment-2637 troy: can't quote the source. suffice to say that in europe and the gulf there are buckets loads of small issues (10-25 million) clns and emtns referencing sovereign baskets. troy:
can’t quote the source. suffice to say that in europe and the gulf there are buckets loads of small issues (10-25 million) clns and emtns referencing sovereign baskets.

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