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Compression? Decompression?

28 May 2015 by lberuti

It seems that the market cannot get bored with the Greek saga. Every day brings its lot of headlines and every day the market reacts. Yesterday market participants left their office hopeful that a resolution was in sight, only to be told today that Greece and their creditors are still far apart on debt talks. Directional positions have been volatile, but so have been relative value strategies. One of the market favourite plays is iTraxx Crossover (ITXEX) vs iTraxx Main (ITXEB). As ITXEB includes 21 banks which will arguably be the biggest victims in a Grexit scenario, a position where you buy protection on ITXEB and sell protection on ITXEX (be careful in choosing the correct ratio though…) has been marketed as a way to protect yourself against such a scenario. And it worked today as the widely used 5x ratio produced the desired outcome. But that was also due in no mean part to the fierce tightening of CAREUK following their results, which can hardly be linked with Greece. One should also notes that ITXEX includes Greek credits (OTE and PPCGA) when ITXEB does not, and it also counts the most sensitive peripheral names among its constituents. That probably goes a long way in explaining why yesterday ITXEX tightened faster than ITXEB in a positive environment for Greek risk. The compression/decompression mechanism between ITXEX and ITXEB is a tough nut to crack.