CDS arbitrage

[UncleNed]

I had a thought the other day, was hoping to get some appraisal/feedback on it.

Could you lock in a riskless (or very low risk) position by writing a CDS contract and hedge that by shorting the underlying reference. My assumption is that if the reference faces credit downgrade/ or falls in value the CDS will rise, but offset by your profit in the short position. If the underlying reference increases in value you can close your short position and the CDS, and walk away with the premium?

 

[Rhody Trader]

You're leaving out the fact that if you're short the bond you are responsible for the interest payments to the buyer.

 

[Martinghoul]

I had a thought the other day, was hoping to get some appraisal/feedback on it.

Could you lock in a riskless (or very low risk) position by writing a CDS contract and hedge that by shorting the underlying reference. My assumption is that if the reference faces credit downgrade/ or falls in value the CDS will rise, but offset by your profit in the short position. If the underlying reference increases in value you can close your short position and the CDS, and walk away with the premium?

So you wanna do a basis trade? Buy CDS/sell bond or vice versa, I'm confused? At any rate, these positions blew up several funds, as well as a big German bank's prop desk that's been in the news recently. I'd advise care and diligence, esp with the repo...

 

[UncleNed]

if a bank was to write the cds contract, could it hedge its liability by shorting the underlying issuers bonds?

 

[Rhody Trader]

It could, if it can borrow the bonds to short them and not end up paying out too much in repo for the borrowing and coupon interest on the bond.

 

[Jordans]

So you wanna do a basis trade? Buy CDS/sell bond or vice versa, I'm confused? At any rate, these positions blew up several funds, as well as a big German bank's prop desk that's been in the news recently. I'd advise care and diligence, esp with the repo...

Hi, do thought the same that why this CDS/sell and why not other one. There are many other options also available better then this one.

 

[arabianights]

Reminds me of this article in the economist.