The Roof, The Roof, The Roof Is On Fire!!

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

So, I admit that I have dubious taste in music.  But what is going on in Greek CDS is extremely important to watch, and take advantage of.

Somehow CDS always attracts analogies to home insurance.  It is most often written about in terms of being able to buy insurance on your neighbor's house and then set it on fire.  I never thought that was a particularly good analogy, but now we have Greece on fire, and the insurance is potentially being cancelled.  The EU is doing all it can to avoid triggering a CDS Credit Event.  The banks, some of whom would benefit from a Credit Event, appear to be going along with the plan.  They are too scared of their regulators to go against them.  Is this totally coercive?  Yes, but it doesn't matter, so long as there is nothing in the bond documentation that can force a holder to agree to a plan if enough other holders agree, then it is a "voluntary" Restructuring and NOT a Credit Event.

Just because the outcome defies what you would expect a CDS contract to do, doesn't mean the conclusion is wrong.

There are lots of reasons the CDS contracts still have value - nothing is actually finalized, even after the deal, there will be legacy bonds around that Greece may not pay on, ultimately triggering a Failure to Pay Credit Event.  Those are valid reasons, but there is also an element of inertia at play.  We have become conditioned to believe a certain thing about CDS - that it is meant to protect bondholders and basis package holders in particular from losses.  It is hard to throw out conceptions of what CDS is meant to do and how free markets are meant to function, but we are seeing it play out.

On the back of this, there are some good trades, and some bad trades.

I would be unwinding basis packages for all sovereign debt.  If you are at a bank or a bank hedging desk, I would be selling bonds/loans and selling protection.  Everything you thought about CDS and how the hedges would work is potentially irrelevant.  Yes, there are reasons to believe that there may yet be NoR Credit Events on Greece and others, but there was a reason sovereign CDS retained Restructuring as a Credit Event - because that was the most likely way to get triggered.  Restructuring is still the most likely way that a sovereign will handle a debt problem, but it will be done in a way to avoid triggering CDS.

I think this is a landmark event.  It isn't fully reflected in the price because bank hedging desks tend to have a more formal process to change how they operate than a prop desk would.  Meetings will occur, but eventually the decision will be made to reduce the basis on bank hedging desks.  It is too logical of a conclusion not to arrive at.  There are also, allegedly a lot of "interest rate" or "bund" traders who have the basis on.  Their knowledge of CDS is dwarfed by their position size, and they may be in denial stage, saying this cannot be the case.  Hedge funds, which can own bonds outside of the IIF agreements may want to keep on their trades.  They can hold the bond and wait until maturity where they either get paid, or can trigger the CDS if they don't get paid, but I think if you sell CDS, you will be able to reload the trade at much better levels.

The Greek basis package is taking a beating today.  The Greek 5 year bond looks to be up 2 points today, from just under 38 to just under 40.  The 5 year CDS is 8 points better on the day (54 down from 62).  The FX moves dulls some of the pain, but that is a big move on a basis package. Sovereign CDS already has a wide basis - the CDS trades wider than the bonds.  I would expect that to invert, possibly dramatically, where the CDS will trade much tighter than the bonds.  I also expect the curves could get steeper again, as the risk of a Credit Event has probably been pushed off. Again, no details yet, but after having gone through all the machinations to avoid a Credit Event, I doubt they will default on legacy bonds in the very near future.  More likely they will find another way to avoid paying par on the bonds without triggering a Credit Event - I've heard suggestions that a bond repayment tax could be created and withheld.  Not sure if that is really possible, but I wouldn't underestimate the willingness of the EU to do everything in their power to avoid a Credit Event, no matter how ridiculous or unfair it may seem.

UPDATE: Most European Sovereign Basis are back to early August levels with only FRA remaining as a positive basis.

In the summer of 2007, the "basis" for corporate bonds experienced a decent size move.  It went from being able to buy bonds and buy CDS and "pick" 15 bps, to about 35 bps on average.  Some basis package buyers loaded up, seeing more  potential "net income" than they had in awhile, with the conviction that it would move back.  Other people (my boss at the time included) saw this as a serious change in the status quo.  Banks, and investment banks in particular, were going to reduce their inventory of bonds.  The funding costs of banks made it less attractive for them to hold bonds.  The basis continued to grow until 100 was the norm, and ultimately reached a peak the day in 2008 when Citadel had an investor call that was impossible to get on because of overload, that talked about their "basis book".

I am not bullish on sovereign credit in Europe but I would not express that view through CDS and particularly not short dated CDS (less than a year).

At its most basic level, a bond is a contract, a loan is a contract, and a Credit Default Swap is a contract.  It is the differences in those contracts that provide differences in value under certain circumstances.  A subtle but important feature of the IIF plan is that they want the new bonds documented under English law - why, because the contract affords bondholders more protection (a valid reason why CDS can remain better bid than it would otherwise).

There is mass capitulation in the CDS market today.  I think in sovereign CDS that move tighter is warranted and is only just beginning (bonds won't move to the same extent at all).  I am less sure that the move in XOVER and Main should be followed.  Part of the move there is people who are on the wrong side of the sovereign move, trying to make up some losses by selling CDS whenever and wherever they can.  I don't believe any of this is a real solution so would not be getting long credit in general, and definitely not in a product where the move already reflects pain in SOVX rather than fundamentals.

There are other areas where I would focus my attention.  The CDS market will be on its heels.  The basis move in particular is catching people off guard.

I think moves in MAIN/XOVER may be short lived, but already are pricing in too much of a spillover effect from SOVX.  I would be looking at selling Muni CDS on big General Obligation Issuers.  Muni CDS trades "Old Restructuring" so it might be harder to manipulate events around a Credit Event here, but I would expect them to try.  With US economic data having been above the worst fears, sellers of CA and NY CDS should experience little resistance.  I would think that is a fast macro trade that could play out well.  There are enough people who believe the fundamentals are improving, they trade relatively wide, and government (FED) support is likely if they got in trouble, and the case that governments would work to avoid a Credit Event at all costs is pretty strong.  The fact that all of those line up in the muni market is why I think selling some CDS there is better risk/reward than piling on the MAIN/XOVER bandwagon (it is much harder to get the will or ability to manipulate a corporate default than it is for a sovereign).

At the other extreme, I would look for some thinly traded names that get dragged along for the ride by the "index arb" crew.  This is definitely harder, as you need to do some more credit work, and possibly face more mark to market volatility as the index arb game isn't going away, but I think with the right selections there is some pretty good money to be made.

Let's take a quick look at The McClatchy Company.  According to DTCC there is $15 billion gross CDS on the name, and just under $1 billion in net.  It is in HY17 so in addition to the fact it has been a long standing CDS name, it is part of the "arb" trade.  MNI has a total of $1.8 billion of debt.  A $125 million loan coming due in 2013 and a small bond coming due in 2014 that has already been reduced to only $111 million outstanding through repurchases (it is so nice to talk about millions instead of billions and trillions).  In 2017 the company has the bulk of the debt coming due, but 5 year CDS, wouldn't expire in December 2016.  The 5 year CDS is quoted at 34, and the 3 year is quoted at 20.  So you would receive that up-front and receive 500 bps - whoever is buying protection on this has big negative carry.  My gut feel is that on a name like this, where the outstanding CDS is big relative to the bonds (CDS net is about 50% of total debt), where there are minimal near term maturities, and a lot of traders will have positions just from "swinging em around all day" as market makers, you could push this CDS dramatically tighter in a short period of time.  This isn't relying on a technical issue with whether a Credit Event is possible, it is relying on the view that anyone short CDS is in pain from a mark to market, the basis is less relevant than ever, and with no debt coming due, and a marginally improving economy, the resistance to some off the run date selling would be minimal.  You can probably hit a 20 bid on 3 year CDS, and by tomorrow that dealer will be begging to get out at 15 since there is no real liquidity.  Clearly credit fundamentals play more of a roll in this trade than the others, but you can probably safely bet that less than half the dealers know the fundamentals and will respond to price action more than anything.  I am sure there are many similar names in the HY index world that could be crushed tighter.

I would also look at LCDX.  I think it offers some value after the recent run-up in HY17 and HYG.

I remain bearish and doubt that this rally has much staying power since the plan doesn't actually fix anything, and it isn't even yet clear if it actually works in the near term.  The sentiment has also changed dramatically and there are far more bulls than just a few days ago so the market is potentially now overbought.  But for some long positions that play the technicals to maximum advantage I would target selling CDS where dealers are most vulnerable and the realization of what has happened in Greek CDS isn't fully priced.

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Select your preferred way to display the comments and click "Save settings" to activate your changes.'s picture

I don't know what any of that means....

jcaz's picture

Berlusconi!  Welcome to the board!

valley chick's picture

sounds kind of "greek" to me...

Eally Ucked's picture

Don't worry they don't either, but it is the life of money, or maybe better term, paper pushers. For us idiots there are one message - there is no more new money and all those XOVER,Main,SOVX,LCDX,HY17,HYG and so on are just terms used by bookies.

schoolsout's picture

A little Drum n Bass to start this thread off....

disabledvet's picture

Let me "name drop" for ya: Harry Markopolos and "i'm probably only one of a few guys in the world who understands this stuff." He claimed "no one would listen"...and yet "the FB I paid him a visit and told him he should be afraid." Funny...apparently someone WAS listening! With the near collapse of the ability of the entirety of the Federal Government to finance itself perhaps they should have rephrased that. Anywho "it's still not our finest hour" as they say...but without Credit Default Swaps we'd all be dead right now. Now we will see how Europe does without them. They have a "system of finance" as well...and it seems quite complex. The oddity is that the strong euro tells us that their finances are far stronger than our own. Perhaps these CDS contracts were far larger than Mr. Tchir thought...but i doubt it. My first impulse is "this reaks of national socialism to me" and i have posted as such--and to think that Europe might think "people aren't watching"...well, let's just say no less than our President now understands the importance of this comment and has..."gained control of the message"...quite ably in my view. In public finance there's no such thing as a tough sell. To quote our friends from the South..."that dog don't hunt."

SkySavage's picture

It means the game has changed completely.  Term restructuring should be considered a "credit event", thus triggering payout on the soverign CDS's.  But somehow this is not happening (I must admit I don't understand how it cannot be happening). 

cowdiddly's picture

The E-trade Baby bought a shitload of CDSs. He can now sell and become the youngest ever Warren Buffet in diapers 

klwilly's picture

Jesus CHRIST.  How poor do us shorts have to get before we just have to give up?

boom goes the dynamite's picture

That is the fucking question of the day.

Stockspeare's picture

Shorted at the is clear to short now. Upside play is done. next time use stops. Holding a short up 2000 Dow points is dumb. I suggest you take up checkers- trading may not be your bag;)

Smiddywesson's picture

Poor bedside manner, but Stockspeare is essentially correct.  If you have a bias, and that bias is to short, then don't do it when retail is also short and especially when TPTB are desperate to perpetuate the system.  The market is completely and utterly fixed, and it has always been so, but that manipulation is more clear now then ever before.  The worse the news is, the harder they will push to keep the market up.  Using stops is good advice, but they won't protect you, so you have to go to options or reduce your position size. 

TPTB are going to hold up the market, change the rules, break the law, deny reality, spread rumors, and lie, lie, lie, until they get what they want.  They want their heads out of the noose and you to foot the bill.  That's not going to happen if the market crashes.  I'm not against shorting individual stocks, but I don't short this market. 

All your gold are belong to TPTBB 

i root for that fat jersey governor's picture

I started some shorts yesterday after being long for almost two weeks. you know what - got crashed and stopped out this morning. And you know what - I am not gonna try to stay in front of the train.

The debate should not be whether these EU moves are stupid or not (we know that, don't we), but which way the market will react to the news!!! That is how we can make (or lose) money. Who cares about how insane these german, french or italians are?? we should only care about our pocket.


klwilly's picture

who is the ASS that gave me one down?  i speak the truth bitch.  you don't like the truth GFY.  

azusgm's picture

Hope you aren't short BAC.

(Why can't that abomination ever die?)

alien-IQ's picture

If you're gonna short this market, it has to be intraday ONLY. Never ever ever ever leave an open position overnight...especially an open short position.

Today, for example, with a 300 point gap up in the DOW, I'm looking to go short at some point....but you can be damn sure I'll be out of all positions before the end of the day.

To hold any positions in this market over night (let alone over a weekend) is nothing short of playing with fire.

disabledvet's picture

"stick with Cramer." He's a bears best friend, too...if you listen.

Stockspeare's picture

Wrong. Now is the time to short and hold. Shorted at the open. Sell the news. The market manipulation is topped out for now. Hold for a nice consolidation and use stops to protect yourself.

GeneMarchbanks's picture

'I remain bearish and doubt that this rally has much staying power since the plan doesn't actually fix anything, and it isn't even yet clear if it actually works in the near term.'

I'm not even sure what being "bearish" means anymore? I can't imagine any sell-off anytime soon...

alien-IQ's picture

Bearish, in todays market environment, simply means "I am not blind to the reality that this situation is FUBAR...and Central Bankers will do all they can to hide the facts and save their own kind".

ChitownTrader's picture

Bearish means "I was short last week and was hoping this would collapse this week, but now have to wait till next week until things settle down"

Lets be honest, when you highlight g3 gdp and make it seem like some type of settlement is resolved, things will rally a bit. There will need to be a couple days where there is a serious retraction considering we are almost at yearly highs.

The Axe's picture

Market wants to believe that it is March 2009 again, only a Europe event...The market could start a 9 month melt up,,,it could be a reply of FED invention in the US..that did not fix anything, but saved the bankers and careful...Cental Bank invention is destruction to a bears P&L

jcaz's picture

LOL- but not a 10 month melt up?


alien-IQ's picture

US Dollar in meltdown mode. Getting completely monkey-hammered.

Imagine my surprise.

The Euro problem is solved huh? Sure it is....

JohnG's picture

Plunging....waiting on gold to sky, why is it not?  Manipulation.

GeneMarchbanks's picture

'US Dollar in meltdown mode. Getting completely monkey-hammered.'

DXY is heavily Euro-measured. It gives no real indication of market place selling of USD in my opinion except in relation to Eurozone.

The currency action is over in JPY...

haibop's picture

look at where gold goes now... cmo network

Gene8696's picture

Guess yesterday's timing to go Short S&P was bad? Oh well, move those into the medium term horizon column.. Or I'll see how weak I am?

This should be a fun two days.. Will be interesting to see how many longs stay in over the weekend. I just called in sick and busted up a dubbie at 7am. About to go long popcorn

LongBallsShortBrains's picture

Yes I added to my Dow shorts.... Ouch. But by short 30 year bond is making up for it 640 here on west coast. Just fired up 1st doob of the day. I'm staying short!

Gene8696's picture

To be honest, I have no clue as to what to expect. But short of needing to open the safe to buy a chicken for dinner, I'm happy watching for the next few days.

At some point the Madam Madof suicide attempt will be responsible for a market move.

paul_Liu's picture

Tyler, what about stocks?

azusgm's picture

Ha! At first glance as the headline, I thought the roof on fire was the copper roof.

myne's picture

We don't need no water, let the motherfuckers burn!

Burn motherfuckers, burn.

fonzanoon's picture

Yup. I have no idea what that means. I am short financials and long precious metals. As far as I can tell when the shit hits the fan I will probably break even. In the meantime I will focus on fantasy football.

TradingJoe's picture

El Shorto! NYMO @ much overbought levels!

Nascent_Variable's picture

So many questions - can the French banks handle a 50% haircut?  Can the ECB?  Is the downgrade of France now a foregone conclusion?  How are the German people reacting to all this, especially if there's a French downgrade?

Europe is such a mess.  It will be interesting to watch the last stand of the central planners, and especially to watch their exit strategies as it all starts unraveling.

Invisible Hand's picture


Not disagreeing with your comment in general but, an important detail: The ECB does NOT take a haircut!

How is that possible that private institutions "voluntarily" give up 50% of the value of an asset but a governmental entity gets par?

Do the banks have no fiducial responsibility to their shareholders to either get 100% or trigger the insurance (CDS)?

We are back to the era of absolute monarchs when the law is what the ruler says it is, nothing more nothing less.  Nothing matters now but survival of the ruling elite.  When Charles I tried this in 17th century, the English revolted and Charles eventually lost his head (literally).  I don't think that will happen today.  We will accept our serfdom and be grateful for the crumbs the powerful leave us. 


BigJim's picture

I agree. The rule of law appears to have finally left the building.

monopoly's picture

Holding short positions is dangerous when markets are broken and succumb to every headline. I am not chasing this and  will just sit and watch the circus. So they have an agreement in words, not actions yet. Anyone buying this is really gambling. But the party goes on.

Feel a lot safer with gold and miners.

jcaz's picture

It's disturbing that you don't realize you're contradicting yourself.....

FunkyMonkeyBoy's picture

Anyone seen GRAHAM SUMMERS lately? I'm wondering how is wonderful crash indicator is holding up?

"Indeed, last week we got a confirmed SELL on my proprietary Crash

indicator. This is the SAME indicator that registered before the 1987
Crash, the Tech Crash, and the 2008 collapse."

kito's picture

leave graham alone, he is tylers brother.

monopoly's picture

And none of the idiots even talk about US. We are next. But it is taking longer than most of us imagined. The tricks these politicians pull out of the hat are truly remarkable.

alexwest's picture

i'd like to look at list of counterparties in Greek CDS.. especially who sold ##cuking expensive CDSs, and

now lobbing to cancel them off...


what next... federal goverment cancells out commodities futures, currencies swaps . what next ?



Waterfallsparkles's picture

What I do not understand is why the Banks are up today.  Especially if the have to take a 50% hair cut and will not be able to collect on their CDS's.  I would think that the Banks would be down.