CDX.HY Question
Hi, I'm having trouble understanding CDX.HY and was wondering if someone could help. I understand that HY.21 trades in price terms as opposed to spread like CDX.IG. So assuming it is being quoted 105/106....that would indicate that the trader would buy index (sell protection) @ 105 vs. sell index (buy protection) @ 106. Fundamentally this doesn't make sense to me as why would someone pay more to buy protection vs. selling it. Where am I missing out here? Thanks
You have it reversed. When you buy the index you are buying protection (@106) and when you sell the index you are selling protection (@105). CDX works just like a stock in that when spreads widen you make money buy buying it and lose money if you shorted it. The difference is price is dealer's spread, you buy @ the offer and sell @ the bid.
That is not right.
For a bond, yield up --> price down. Holding risk free rate constant, spread up --> price down. This convention is preserved for CDX. Elaborating further:
What CDX IG and CDX HY have in common is buying --> you want what you bought to go up. However IG is quoted in spread terms whereas HY is in price terms. It is not actually a spread over the risk free rate as you would have with a cash bond (bond yield - treasury yield = credit spread, which treasury yield determines which kind of spread) but the number is analogous to make it comparable. Now remember that this is CDS which is protection (default insurance) so wider spread = more risk = your protection is more valuable.
CDX HY being quoted in price is a bit different. The price is actually 100-the upfront payment. The best way to think of this is that instead of having the coupon change every time the contract changes in value (riskier = higher spread) there is just a payment between the protection buyer and seller, and a standardized coupon. If the spread < coupon the protection seller pays the buyer before the buyer starts paying coupon payments, and if spread > coupon then the buyer pays the seller upfront and then starts paying coupon payments. So at $100 price there is no upfront payment. $100.01 small payment from seller to buyer, $99.99 small payment from buyer to seller, and so on. The contract has a spread too but it is quoted in price. Price down --> spread up. So buying CDX HY = selling protection --> you think spread will tighten.
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