Basis trade opportunities decline as default market continues to tighten

The European default swap market continued to tighten substantially across certain sectors this week, correcting the recent dislocation between cash bonds and credit default swaps (CDS).

Strong tightening in default swap premiums has eroded the basis versus cash in major sectors of telecoms, autos, media and retail, Merrill Lynch said yesterday in a research report. The default basis is the difference between the credit default swap spreads and the bond asset swap spread. The basis decreases when the CDS tighten faster than the cash.

“Investors who bought CDS protection are unwinding their trades by selling protection,” said Atish Kakodkar, a vice-president in credit derivatives