tightening credit spreads: interest rate goes down??? hence, sell CDS widening credit spreads: interest rate goes up??? hence, buy CDS but both in schweser says in the context of a bearish outlook? im confused here wat they mean by bearish? schwser book 5 page 318
ok now i get it. when do u sell CDS? = when interest rate goes down because they pay lower interest rates… so credit outlook is good. = therefore an investor who wishes to hedge asset would buy a receiver option if he believes interest rates will go down = so as a CDS investor u want to enter into an option agreement which allows you to sell at a higher price (long the underlying asset, asset here means the reference obligation… i think, correct me if im wrong). when do u buy CDS? = when interest rate up … so credit outlook is bad for the company on higher cost of debt. = therefore an investor who wishes to hedge their liability would buy a payer option if he believes interest rates will likely go up = so as a CDS investor u want to enter into an option agreement which allows you to sell at a higher price. (short the underlying asset, asset here means the reference obligation). need clarification why its a long when u are entering an agreement to sell at a higher price
my opinion, correct me if wrong: tightening spread: economic good, sell CDS to earn the premium. widening spread: economic bad, there is a lot of default, so buy CDS, pay the premium to get the pay-off should there be default event.
Schweser Errate: Page: 319 - Correction Near the bottom of the page, under “Options Trade,” the second sentence of the bullet should read, “An investor with a bullish outlook would buy a receiver option in anticipation of tightening credit spreads.” ( Posted: 2007-12-04)