TTurk

Berkshire Hathaway: Proof That the CDS Market Is Irrational

It is not irrational if you are a large trader like a hedge fund and you first take a major short position in a company's bonds, preferred stock or even common stock. Then with a relatively small amount of money buy CDS's. Since the CDS market is relatively thin, a relatively small purchase will move prices higher. As the CDS premium's rise, guess which way the bond and stock prices will go as more traders notice the CDS premium rise?

The trade is very rational and doesn't take very long to become profitable. In a short time both postions become profitable as more traders pile on.