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Does Index Alone Give The Whole Picture?

21 January 2015 by lberuti

In Europe, activity was fairly subdued during the first part of the session. Given the level of expectations that built up ahead of tomorrow’s ECB’s meeting it was not surprising to see investors remain on the side-lines. Then the headline hit that QE might amount to €50bln per month through 2016, so a fair amount more than the €700bln rumoured last week. That triggered some protection selling on indices across the board, sending iTraxx Main and iTraxx Crossover 1.5bps tighter to 56.5bps and 10bps tighter to 323bps respectively in a flurry of trading. So from that angle, the European credit market looks pretty bulled up. But at the same time, the implied volatility of credit indices options was consistently bid up throughout the session. On the February expiry, which is the shortest to capture the ECB’s meeting, the price of out of the money options (typically with a 25% delta) went up by 6 volatility points. Investors have been busy buying protection against tail risk, just in case the market is disappointed by tomorrow’s actual decision.