18 August 2017 by pdonnat
Credit indices were again very weak during the whole trading session. The investment grade European credit index is noticeably an under performer. European credit index players have been caught off guard. Their consensus was on a “grind tighter” into the September roll – a smooth tightening of the index -. The 20th of September, six month will be added to credit index protections. Historically, hedging activity reduces ahead of the roll. Selling protection ahead of the roll has been a winning strategy over the last few years. The recent price action has upset this mechanical plan. They are too many buyers of European credit index protection. The index is now very expensive to buy compared to the cost of its members. Moreover, the cost for hedging its members is also very expensive versus the cash instruments they are refering to. European credit index protection should be a sell. Popular in the market today, a plan B was offered to "play safely the roll effect": buy September receivers options. The option expiry is the same day of the index roll, the double witching for credit indices. The receiver options are still cheap. The implied volatility repricing is contained. Plan B looks attractive.