On Thursday night, after it became clear that JPM has lost at least $2 billion on what is most likely an IG9 Index skew (Index less Intrinsics) trade gone horribly wrong, we first predicted [8](and promptly were piggybacked on by other various financial blogs) that based on various factors, there is about $3 billion more [8] in the pain trade coming in JPM's general direction, once IG9 blows out to catch up to a fair value not supported by JPM(artingale's) infinitely backstopped prop desk. Sure enough, by closing on Friday, IG9 (and the entire IG curve), had blown out wider, by a whopping 10 basis points: one of the biggest intraday moves in nearly a year [9]. In P&L terms, by close of Friday, all else equal, JPM had lost another $2-3 billion on the same trade it had lost over $2 billion since the beginning of April. We expect to hear confirmation of this shortly. Which however brings another question: has JPM closed out its losing trade, or is the entire move in the index (and to a far less extent in the intrinsics) due to hedge funds who have piggybacked on the "crush JPM" trade? The truth is we don't know, and until we get the latest weekly DTCC data on CDS notional outstanding we won't know. However, our gut feeling is that it would have been virtually impossible for JPM to lift every single offer in unwinding a $100+ billion notional position without sending the entire IG curve multiples wider. Which is why keep a close eye on the IG9 10 Year skew - this is where, as ZH first noted, the action is. If the skew soars, it is likely that the runaway train will keep going and going, until JPM issues a formal announcement that the firm is fully out of the trade, together with a final tally of its losses, which will probably be double the reported loss as of Thursday. At which point IG9/18 will see an epic ripfest as those short risk will scramble to cover.
As the chart below shows, as of Friday, the index was still 7 bps rich to intrinsic, however the spread collapsed by nearly 50% from the day before. If and when the skew goes positive, would be our all clear to get out of dodge. Until then, JPM will likely see far more pain, even if, technically, it won't, following rumors its entire London CIO desk may be now in jeopardy, meaning it will be up to the middle office to unwind, at an even greater loss to the firm. And compounding the issue will be the general risk off nature in capital markets over the next few days, following a plethora of European sovereign bonds, and, oh, the little issue of the Eurozone potentially falling apart in a few weeks. All of which will likely see the continued widening in various IG points, until JPM issues at least some more color on its current involvement in the trade.
IG9 - 10 Year Skew: ripfest, but still a ways to go:
[10]
Someone else who believes that the trade is now over, is Peter Tchir. We don't quite agree, but we do believe IG9 (and 18 by proxy) longs should be careful - very soon covering an IG long CDS position may well be the pain trade.
From Peter Tchir of TF Market Advisors
The Coolest Trade I Ever Saw!
On the coolest trade I ever witnessed, I was an unwitting participant. In the end, I don’t know if any of it is true, but this is the story I saw and was a part of, and the firm’s P&L seemed to back it up.
I only mention it now, because I can’t help but think Jamie Dimon is pulling something similar. With Sarbanes Oxley and everything else, I’m not sure he could be, but there is a nagging doubt in my mind about “piling on” being the right trade.
I also can’t help but remember back in 2008, where Citadel had a conference call. That was unusual enough. More unusual was how easy it was to get the number. Ken went on about the basis (long corporate bonds vs short CDS). I remember liking the basis at that time, even had on a tiny bit, but I wanted to buy because I figured it was at ridiculous levels, the funding the Fed was supplying would help the market, and by the time Ken was so openly talking about it, you had to know the unwind was almost over.
So, anyways the trade I remember as the coolest trade was way back in the early 2000’s. I was at DB at the time doing some HY CDS, Synthetic CLO’s, Total Return Swaps and a few other things that most people hate. But the big story at the time was talk that the government would stop issuing the long bond.
The bond was going up almost daily. There was talk about the scarcity and that it could go a lot higher in price. The rumor was that DB was short. It started as a small rumor, but got around. One morning, the long bond opened up more than a point. It kept grinding higher. It didn’t matter who you were at DB, you were being asked by the street, by clients, by competitors about the trade. Everyone thought DB was short and getting killed. The size was supposedly large (by the standards of the day which are a fraction of what they are now). I remember being nervous about my bonus.
What the heck was going on?
Then it happened. Edson Mitchell or his assistant came out of “mahogany” row and called the head of rates (who oversaw treasuries) off the desk. Myself and countless others were immediately on the phone and Bloomberg messages telling people what just happened. Holy cr*p this must be bad. The head of rates was called off the desk. That NEVER happens. And it was not to celebrate. Wow. The long bond spiked further, I think at one point it was up over 3 points – a huge move. The rumors of losses were growing by the second. People were wondering if they should trade with DB. The “usual histrionics” that were blowing the situation way out of all proportion.
According to legend, and the P&L seems to have backed it up, the rates desk was actually LONG treasuries. That extra 2 point gap made 100’s of millions of dollars for the firm. Whether they had ever been short, I don’t know, but they had turned the position and were now massively long and profiting from the move. How they didn’t just take the money and be happy I will never know. But to go through the charade of calling the head of trading off the desk and causing an immediate spike that they sold into, has to be the single coolest trading thing I’ve ever seen.
Be careful betting against JPM and the trade they allegedly have on and allegedly still need to unwind and might allegedly lose a lot more money on. I’m not saying this is a head fake and I haven’t recommended closing the trades in TFMkts Best Ideas™ that benefit from the unwind, but I really don’t believe, that in spite of Sarbanes Oxley, we are getting the full story, and not possibly being played a bit.