Negative Ghost Rider, the pattern is full

This post is little more than a victory lap so please feel free to stop reading now.

Something strange happened yesterday. In the morning I was looking through data from the past two debt ceiling clusterfucks trying to think of an ideal way to structure a trade for a potential impasse. Having remembered that the US sovereign CDS curve had some wild fluctuations the last two times I focused on another possible flare up on the front end. This is a rather illiquid little backwater and a truly useless market for anyone actually trying to hedge risk on a treasury portfolio, but it’s a fun spot for doing some punting.

As it stood this morning 1y CDS were at 13bps with a 6bp spread on the bid ask and 5y CDS were at 24bps with a 4bp bid ask spread. Both of these levels were significantly below their (short) historic averages.

Since I can’t trade these in my PA, my desk doesn’t actively take risk in these instruments, and our clients don’t particularly care for small illiquid trades I thought I would share my thoughts on twitter.

I was happy that a number of people thought it was an interesting trade and got a few follow ups on the matter but most people just thought it was a halfway funny joke about Top Gun.

Then at the end of the day I was going through my pricing rundowns and I saw that this happened.

1y CDS had shot up by 45bps since the morning. Upon further examination I noticed that the aforementioned 1-5y spread went from 11bps to an all time record of -28bps. As shown below this is a 5.9 standard deviation event, and if you believe that derivative pricing follows a normal distribution this is something that should be seen once in every 300 million observations.*

And here’s the one day change for the curve.

I am going to run with the assumption that I just happened to have timed this recommendation perfectly, but I will hold out an inkling of hope that just maybe someone who reads my tweets banged this level and moved the market.

*If you think illiquid derivatives follow normal distribution patterns you should stay away from them, as well as any other assets that might prove too complicated for you.

3 thoughts on “Negative Ghost Rider, the pattern is full

  1. Pingback: Credit Default Swaps Aren’t the Canary in the Debt-Ceiling Coal Mine | Matthew C. Klein

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