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ITXEB vs CDXIG: The Domino Effect

25 April 2014 by HCM

The situation in Ukraine has brought some volatility to the market over the last few days. There was no panic so far, but investors have been looking for hedges against a potential deterioration of the situation and quite a few of them have chosen options on credit indices. They bought payer options (which give the buyer the right to buy protection at the maturity of the option) on iTraxx Crossover series 21 (ITXEX21), and also on iTraxx Financial Senior series 21 (ITXES21). The latter were the most popular, and that generated a negative gamma position within the dealer community. So today, when the market felt weak and tested recent wides, dealers felt the need to buy iTraxx Financial Senior aggressively which led to its underperformance compared with all other indices (it widened at the same speed as iTraxx Financial Sub when the ratio is usually 1:1.5). In turn, this underperformance impacted iTraxx Main. Such phenomenon seems to be the main driver of the recent widening of the spread between the US investment grade index (CDXIG22) and its European equivalent. From a tight of 3bps 10 days ago, the CDXIG/ITXEB spread closed at 6.5bps tonight.