skew trades

Reuters had a neat article today about how JPMorgan’s CIO embarrassment increased credit spreads for a bunch of investment grade companies. The 121 companies included in the CDX.IG.NA.9 index, in which JPMorgan apparently had a $100bn long position, saw their CDS spreads spike in the days after JPMorgan revealed its losses – and its intent to unwind that position – last month. As Reuters puts it, those companies’ CDS spreads

became more like the pawns in a battle between JPMorgan and hedge funds on the other side of its bet. This struggle so dominated a corner of the market that it sent false negative signals about the credit quality of some major companies whose underlying finances were largely unchanged, market experts said.

JPMorgan, sort of strangely, disagrees:

A JPMorgan spokeswoman said there was no causal link between the credit derivatives prices and the trading tied to the bank’s losses. The theory, she said in an emailed statement, “is wrong and ridiculous.”

But the Reuters analysis showed the 121 companies underlying the index of credit derivatives at the heart of the trading battle had a sharper increase in default insurance costs than 41 companies in a separate index that was not believed to be part of the big bets.

That statistical analysis – CDS on companies in the index went up by more than CDS on some other companies – is more suggestive than compelling, but also more suggestive than “wrong and ridiculous.” I like suggestive when I can pair it with a story. What is the story – the actual trade that would do this? Read more »