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So Predictable?

20 October 2015 by pdonnat

For a trade, the credit investors are selling protection, adding risks, to benefit from the market friendly ECB. The ECB convenes in Malta the next 2 days. It is supposed to deliver more QE. In conjunction, tomorrow is the monthly expiry for the credit index option market. Both factors are supportive to the credit index market. At the same time, there is a bid for single name credit default swaps. As a consequence, the basis, the difference between the index and the cost to replicate it with single names, is stressed. The investment grade basis is closing at -30cts (-6bps) in Europe and at -40cts (-8bps) is the US, when both indices are trading around 80bps. That is respectively 7.5% and 10% returns that investors are losing in trading credit indices rather than trading the single names. This is the price for liquidity or a herding effect. We should to be cautious post option expiry, tomorrow at 4 pm. If investors start to think about the market positioning and the index basis, we could have some repricing.