Are there any other ways to take a short position on a corporate bond other than buy CDS against it? Can you actually "borrow" a bond and sell it? Sounds risky and expensive considering the coupon payments, so wasn't sure if there is even a market for that.
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You can (and I've seen it happen), but it's super illiquid and borrow fees are very high. Almost everyone just uses CDS.
what other kinds of trades could you place other than puts to have the same strategy? new to this..
What this person says. You can definitely short a corporate bond but it might be less liquid. Rebates depend on how tight availability is which is based on the issue.
Can people who don't know or haven't worked in the real world stop making up sht? What if the guy went into an interview and repeated this nonsense? You could cost him a JOB.
For simplicity, I'd just buy an inverse-ETF similar to what I'm trying to short.
Another option is to simply short an ETF. If that doesn't work for you, you could try purchasing a mutual fund like RYAQX that moves inversely to the general direction of the treasury market. You can sell futures short. You can buy bearish puts on ETFs for whatever sector you're trying to short.
Really, there are a lot of ways to accomplish shorting bonds with varying degrees of difficulty and risk. Me personally, I tend to favor inverse-ETF purchases - quick, simple, easy to do.
This is fine for obtaining short exposure to an index but doesn't help with getting short exposure to a single name (which was the OP's question).
Just read through all of this. You guys are definitely right - I wasn't paying enough attention to the OP's title, oops.
I thought OP was trying to do this for a personal portfolio, so the difficulty in trading CDS with $800 led me to think of inverse ETFs.
Yes, you can short a bond, if there is a holder willing to lend. There will be a borrow cost. Your trader will talk to the sales coverage (b/d's) to find out if the issue can be borrowed and at what rate. Plus you pay the coupon to the holder you've now created by selling short.
If the coupon is 9 pts, and the borrow is 1 pt, then you will pay 10 pts in one year's time. You need to have a view that the bond will fall 30 pts over the next year to make your 20%, assuming that's the kind of reward you are going for in the short. That's generally tough to get conviction around. It's also generally tough in a credit environment like today's. Its like shorting stocks in the late 90s.
Thank you for actually posting something correct and coherent in this thread.
But there are far better reasons to short a bond than to outright short.. I would say most of the short interest in the market are part of some cap structure package, so that coupon issue is largely irrelevant as you fund the coupon with the other side of the trade.
You make a worthwhile point (many people are short credit with an offset of some kind, either explicitly as a package/basis/hedged trade or implicitly by being long a portfolio of other credit against their short portfolio) but I think you overstate the case a little bit.
Intra-cap-structure trades can be structured to be carry flat, carry neutral, or carry positive, but truly free lunches are very rare in my experience (which is admittedly limited to just that and is obviously not comprehensive). At the end of the day a trade starts with a directional view on a security-either in an absolute or relative to another. Any time you add another leg to a trade, you're paying SOMETHING for it-either by giving up upside, increasing the amount of capital tied up in the trade, or introducing other various types of event or basis risk into the trade.
(Note to those who are not familiar with the terminology: "carry" refers to the cost you pay to "carry" a trade on your books-ie if the trade is to buy a bond outright, your "carry" is the interest you earn; if you buy protection CDS, the carry is the spread you pay to the protection seller. If you are hedged-for example buying a bond and buying CDS protection, your carry is what you earn (bond coupon) minus what you pay (CDS spread.)
Let's take a common example of the kind of stuff you're referring to:
Short Company A junior paper/long company A senior paper This is a very common one in my experience. Basically you think there's a good chance that the junior paper (say unsecured bonds) are over-priced and/or likely to be impaired in the future. You short those, and buy senior paper (secured bonds or TL) against them.
Pros: Coupon from the senior paper offsets your cost of carry on the short (coupon you pay out plus borrow costs) Cons: Usually doesn't 100% offset your carry (at least not on a 1x1 ratio) as the senior debt should trade tighter (on a yield/spread basis) Gives up some of your upside if the trade goes your way-it's rare to see junior debt trade off meaningfully (say, drop 20-40 pts) and not see the senior part of the cap structure move down as well. Let's say you short a 10% bond and buy a 5% loan, and 2 years later, the bonds drop 40 pts and the loan drops 10. You've paid 10 pts in carry instead of 20, but you only made 30 pts instead of 40-total PNL is flat, on top of which you had to tie up cash to buy the senior security. (admittedly the #s in my example are cherry-picked) Introduces some convexity issues-for example TLs are usually callable/can be repriced. If your trade goes against you, the TL you are long can only trade up to some small premium to par whereas the bond can trade to a yield-to-call. More complicated issues could include collateral/recovery in bankruptcy but at the core its a similar impact.
Depends on the shadow bank you decide to negotiate your repo contracts with
That would be a perfect solution if most inverse ETFs were not total junk products.
Zeroblue asked a followup that I will try to answer here.
When Einhorn says that levered equity is like a call option on the debt, he doesn't mean it literally. He means that when you pay the offer price (option premium) to buy a share (call option) you get something that has little or no value if the company defaults/the debt isn't eventually worth par, and increases rapidly in value if the enterprise value is in fact worth more than the amount of the debt. It's actually not a perfect analogy (because the upside of being long the equity is uncapped whereas being long a call on the bond is capped at par, or whatever premium to par the bond can trade to but in any case not infinity) but the point stands-the value of equity in a levered company is highly correlated to the eventual value of its debt.
You can pick different ways to define "levered company" but generally it would be some combo of high debt/EV and/or weak levered FCF. (Any company whose debt you are considering shorting should probably fit this definition).
Kenny MF Powers, hot damn its good to have you back.
That awkward moment when someone knows what they're talking about
Guys, thanks for all the responses above - i haven't been on WSO in a week and didn't realize how much good info was posted on this thread. The original qustion was related to prepping for an interview case study and i actually didn't get any questions around it. But good stuff nonetheless!
Credit long/short, distressed, and fixed income HF wannabes - read the shit KP is writing. If I knew all this stuff a year ago, it would have been MUCH easier to transition from banking to HF.
I distinctly remember at least one dream-job offer that I lost in the final round because I didnt understand credit derivative trades.
Also, for OP...
One thing I dont think was mentioned is that the CDS markets are much less liquid and have less breadth than they did at the end of the last cycle. You will very frequently be in a position where you want to short notes with no CDS available.
Nowadays, only the most liquid of the liquid names have quoted CDS. Borrowing/shorting notes is therefore extremely common.
Want to revive this thread from a few years ago, as I am curious about general mechanics and liquidity. Just to clarify, the questions below relate to a single corporate issuer's bonds (not some index).
1) Assuming decent tranche size ($400mm+) and issuer isn't distressed, what would typically be the cost to carry the short in addition to coupon pmt? 2 pts?
2) If you want to short a fairly large position (say $50mm) and if brokers don't have the inventory, how are they sourcing it for you? Would existing bondholders (i'm assuming mostly long-only MFs and AMs who bought the bond at/near par) actually agree to lend out their exposure? Kind of hard for me to fathom.
3) The above brings up the liquidity issue, how big can short interest actually get in a bond? Is it somewhat constrained by what banks have on their desks?
4) If the name is distressed (say trading in 60s with more downside), how much harder does it get to source a short? How much more expensive can borrowing cost get?
5) What are some other reasons to short a bond tranche other than taking a fundamental bearish view on the issuer or that particular part of the capital structure? Want to understand what other common rationale there are out there.
5) The bond being one leg of a basis trade could be one other possible reason...
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