Tom Jacobs

Writing Naked CDS: When Murder (and Betting on It) Is Legal

There are plenty of agents with no commodity exposure who either agree to deliver or accept delivery of commodities in futures contracts and they perform the role of enabling those with said exposure to hedge and no one wants to take them out to the woodshed. Tangentially, a number of academic studies showed that those tech stocks that could not be shorted due to technical and other factors experienced the largest degree of "bubble" in their shares during the late nineties boom in tech stocks. Thus, I would conclude that the idea that one has to demonstrate an economic exposure to hedge in order to short credit or that shorting both credit and equity is somehow evil is misguided, at best.

I also liked this line from the Barron's piece: "If the total cost of buying a bond and insuring it to par is less than par, it creates an arbitrage that ultimately destroys capital." How does this destroy capital? The arbitrage is to buy the bond and buy protection on the CDS which will drive up the bond price and the cost of insurance until par is reached and the arbitrage is gone.

Tom