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Arbing Moody's Sovereign Ratings Via CDS Pair Trades

Tyler Durden's picture




 

Now that sovereign CDS (and ratings) are back in vogue with everyone finally expecting the world to relapse into a double dip, Zero Hedge has compiled Moody's sovereign ratings and spread these alongside the CDS spreads in any given bucket to proposes several trade ideas taking advantage of Moody's market lagging inefficiency.

We have done this for all countries Aaa through B3, and grouped the countries by rating bucket (i.e., Aaa, Aa3, A2, Baa2, etc), taking the average spread of the countries in the bucket. Subsequently we charted the variation from the average for any given country in a particular rating bucket. The result is charted below: it should serve as a useful platform on which to build a trading portfolio used to arb Moody's ratings. The rationale is simple - as the spreads in any given bucket should, on average, be very much in line, it is possible to trade outliers that are far away from the average by incorporating them in a convergence trade. One possible trade is therefore to sell Spain CDS which at 218 bps is 154 bps wide of the Aaa average of 64. The other side of the trade could be purchasing CDS in any name that is abnormally tight to the average, such as Australia or the US. Of course, since a Moody's rating is always a lagging indicator, a likely better trade is to position for future Moody's ratings actions: in this case the trade would be to Buy Spain protection on the expectation the country gets bumped into the next lower rating bucket, Aa1 (or lower), where average spreads move progressively wider. The spread can be hedged by selling protection in a country the is a tight outlier in the expected "landing" bucket. For instance, if one believes Spain will be notched twice, to Aa2, the trade would be to Buy Spain CDS, and Sell Japan, which has an Aa2 rating. Of course, there are many other possible trades that can be created. We present a chart for all countries that diverge from the rating in the A-bucket (from A3 to Aaa), although we note that the spread expansion is not linear due to sample sizes: for example the average spread in Aa3 is 65 bps while the allegedly less risky Aa2 is 124 bps: potentially another arb would be to create a spread compression by buying the Aa2 CDS bucket and selling the Aa3 for a 60 bps spread convergence, DV01 neutral.

We will present the comparable data for B-rated countries tomorrow.

Below is the chart that shows the variation from the bucket average for the 7 A-handle countries.

Raw data for A-rateds with spread.

 

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Thu, 08/12/2010 - 15:04 | 518375 firstdivision
firstdivision's picture

It is 3pm and PPT is in full effect, going green by close.

Thu, 08/12/2010 - 15:08 | 518382 Jason T
Jason T's picture

with a little of your front running 5 minutes before.

Will funds take advantage and sell into it hard?  They have no cash and are flooded with withdrawal requests from what I can tell.

Thu, 08/12/2010 - 15:09 | 518383 MrTrader
MrTrader's picture

And everybody is invited to be a part of it....

Thu, 08/12/2010 - 15:14 | 518397 docj
docj's picture

Volume peters out - PPT rushes in to Do The Lord's Work.

God bless 'em.

Thu, 08/12/2010 - 15:24 | 518426 william the bastard
william the bastard's picture

The lonly bid in town

Thu, 08/12/2010 - 15:26 | 518430 traderjoe
traderjoe's picture

In my own twisted opinion, I think PPT, PTB will let stocks drift lower in a controlled fashion for a little while. This will raise the hopes of a Republican victory in Nov, which can be a theme of bullishness on CNBC for a couple of months. And will give the sheeple the sense that they are "throwing the bums out" and actually have a choice/vote/participation. 

It's a sort-of double secret probation/reverse psychology line of thought. Also the news flow has been bad enough that they might want a chance for the shorts to load up, push the market down, and then when there's little news flow pop the market when people least expect it. Wash, rinse, repeat. I spend time looking at the eco calendar now wondering when there won't be news - as a good time for them to start a rally. 

Thu, 08/12/2010 - 15:44 | 518467 firstdivision
firstdivision's picture

Looks like Ben is taking he afternoon dump instead of minding his E*Trade account.

Thu, 08/12/2010 - 15:15 | 518400 firstdivision
firstdivision's picture

Hahaha!  What is Spain doing with a Aaa rating?  Love the CDS spread on it as opposed to it's other Aaa rated peers.  

Thu, 08/12/2010 - 15:32 | 518441 william the bastard
william the bastard's picture

Moody's has as much credibility as Chuck Barris

Thu, 08/12/2010 - 15:17 | 518409 John McCloy
John McCloy's picture

Here are some more greener than expected shoots.

Section 8 Welfare Housing Authority Riots. 30,000 show up for bread evidently the Government forgot the circuses.

http://www.cnn.com/2010/US/08/12/georgia.housing.crush/?hpt=Sbin

Wall Street Also Saw Protest from the Unemployed:

http://www.nydailynews.com/ny_local/2010/08/08/2010-08-08_99ers_looking_...

 

Things are getting interesting folks. Now back to your regularly scheduled ramp job.

Thu, 08/12/2010 - 15:27 | 518431 william the bastard
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I'm calling for unplugged GSEs and Texas seccesssion

Thu, 08/12/2010 - 15:54 | 518491 grunion
grunion's picture

I dunno, they just might be able to do it...

Thu, 08/12/2010 - 15:42 | 518464 firstdivision
firstdivision's picture

In the protest article, I found this a little disturbing

share YouTube videos about suicides among their ranks.
Makes me wonder if suicide rates are creeping upward
Thu, 08/12/2010 - 16:11 | 518524 rapunzel
rapunzel's picture

could not open real story. more .gov propaganda because they want old people to die so not burden their bigger plan. similar what read GW story and hiding dead wildlife. unfuckingbelievable this all is probably the truth. stopped reading HOEPO, but saw headline pat tilman's dad says Fuck you to ?

Thu, 08/12/2010 - 15:42 | 518462 lance_manion
lance_manion's picture

Does Moody's not rate Canada??? 

Thu, 08/12/2010 - 21:06 | 519074 Cheeky Bastard
Cheeky Bastard's picture

Well, we have discovered there is no Canadian CDS. You may catch a short bid/offer, but it becomes non-existent by the end of the trading session. Furthermore the frequency and liquidity of Canadian CDS is probably the worst in the total debt Universe. Worse than any synthetic [yes even TABX which is not priced for the 6th consecutive month now]. We were surprised to see that Canadian CDS is not and, for the most part, can not be bought or sold. Simply, one of the few [maybe the only] significant economies for which a CDS instrument is not available. Moody's does [as well as other RAs] have a rating on Canada, but you dont need to be rated to be traded [mostly true only for lower tranches in bespoke structured products]. 

Thu, 08/12/2010 - 21:30 | 519095 rapunzel
rapunzel's picture

LUV, your Furthermore's.

Sat, 08/14/2010 - 21:14 | 522137 ZeroPower
ZeroPower's picture

Bingo, excellent info CB. Some days go by without a single swap trading on Canada's credit, and the day's you do happen to find someone to take the other side of the trade the spread will be wide enough to make it not worth it.

Thu, 08/12/2010 - 16:34 | 518577 youngandhealthy
youngandhealthy's picture

Look at the new Nordic EURO....Sweden, Norway, Denmark.... EURO Lite! or why not Nordic Lite

Thu, 08/12/2010 - 16:33 | 518579 hellboy
hellboy's picture

Which CDS is this? 5yr? Is 5yr CDS what people mean when they say CDS or a different one? Thanks.

Thu, 08/12/2010 - 18:53 | 518914 NotApplicable
NotApplicable's picture

Now wait a minute. Sovereigns can't default!

Trichet told me so.

Fri, 08/13/2010 - 06:53 | 519484 BeerGoggles
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And where can the average person get a CDS from?

Sat, 08/14/2010 - 21:15 | 522139 ZeroPower
ZeroPower's picture

Theres an app for that.

Do NOT follow this link or you will be banned from the site!