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Indices: They Bull Flattened

09 May 2014 by HCM

We commented recently the fact that single name CDS curves only marginally flattened during the move tighter which took place over the past few weeks. It is a somewhat different story on indices, at least on the short end. If the 5 year 10 year curve has been pretty resilient on the investment grade indices (iTraxx Main in Europe and CDX IG in the US) and is still trading at the same levels as a month ago (the 5y/10y iTraxx Main is currently worth 45bps against 46bps early April), the 3 year 5 year curve has flattened more meaningfully. 3y/5y iTraxx Main is currently trading at 28bps against 32.5bps right after the roll. This can be illustrated by plotting the behaviour of the 10y maturity of the different series of iTraxx Main, the S10 10y being used as a proxy for the S20 5y since they have the same effective maturity. Selling 5 year CDS and buying 3 year CDS is a gamma positive position. If risk premia go to 0, which is obviously what the majority of investors think given the recent market trend, the 3y/5y curve will keep flattening and you will make money. If there is a bump along the road and uncertainty increases, then options become more valuable and short dated CDS are commonly seen as options on the health of the corporates.