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Sell the Basis

07 August 2014 by HCM

The iTraxx European basis is closing at 24cts or 5bps equivalent running spread. An investor can sell the index 5bps above its fair value excluding transaction costs. This is a very large level for the European investment grade CDS, the basis is 7% of the total CDS premium. Leveraging the basis 14 times, the investor return is similar to an outright credit investment without credit exposure and without market risk exposure. The only remaining risk is the basis risk but has the chart indicates, they are few point in the recent history when the market has traded as disconnected to the fair value as today. The picture is similar in the US but the basis is close to 15cts and there is room for another 5ct of basis widening.