Credit derivatives disappoint


Chicago's exchanges have suffered a setback in their attempts to bring credit derivatives on to the trading floor. The Chicago Board Options Exchange (CBOE), Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) all listed credit derivatives contracts in June, although none had registered a single trade by the time Risk went to press. It follows similar disappointment for the first exchange-traded contracts, which were listed by Frankfurt-based derivatives exchange Eurex in March.

"As we anticipated, it's a very slow start. We do get a lot of enquiries but we haven't done a trade yet," says Joe Levin, vice-president for research and product development at the CBOE in Chicago.

The CBOE listed 10 single-name binary credit default options on June 19, with expiry dates in September 2008 and September 2012. They are referenced to Michigan-based motor companies General Motors, Ford and Lear Corporation, and New Jersey- and California-based homebuilders Hovnanian Enterprises and Standard Pacific. If the underlying entity defaults, they offer a fixed payout of $100,000. At their launch, New York-based Jane Street Specialists was named as the products' designated primary market-maker.

Levin believes building liquidity in the contracts will take time. "This is a complicated product, it's a unique asset class, these are complicated issues and we are not expecting it to take off like an index product that people are familiar with," he explains.

Uncertainty over the launch date of the contracts may also have negatively affected participation in the products, he adds: "It's a question of the price vendors getting ready for this. For example, (New York-based trading platform) Bloomberg still does not display our products, and they're working on it. They started late."

Levin hopes this problem will be resolved within the next two weeks. Bloomberg did not respond to requests for comment.

The other Chicago exchanges have also experienced slow starts to their contracts. The CME listed credit index futures two days prior to the launch of the CBOE contracts, linked to the CME's own North American Investment-Grade High Volatility Index of 32 equally weighted reference entities. Like the CBOE contracts, these had yet to register a trade by June 25.

Although the CBOT's credit index futures were only listed on June 25, they also had not traded during their first full day on the exchange. The three-month CBOT futures are based on the CBOT CDR liquid 50 North American Investment-Grade Index, maintained by New York-based research firm Credit Derivatives Research. The index represents the average spread of the 50 most liquid investment-grade names in the North American credit default swaps (CDSs) market. The settlement value of the future is $500 multiplied by the value of the index, meaning the price of the contracts increases as CDS spreads widen, up to a maximum spread limit. Neither the CBOT nor the CME have any market-makers for the new contracts.

Despite the lack of trading across the new credit derivatives products, the CBOE and the CME still plan to extend their offerings. The CBOE has set a target date of July 23 for releasing basket credit default options, although these still await approval from the US Securities and Exchange Commission. It is mulling launching two sector-specific baskets, based on automotive and homebuilding companies, with another diversified basket of up to 50 single names. The CME has also gained regulatory approval for a single-name credit future, but there is no firm launch date for the product.

Meanwhile, Eurex says it is moving towards a "more creative partnership scheme" with investment banks, after all but one of Europe's major dealers boycotted its credit derivatives futures. It is preparing to offer incentives to attract more liquidity providers to the five-year contracts, which are referenced to the Frankfurt-based International Index Company's iTraxx indexes of European CDSs. Currently, Societe Generale Corporate and Investment Banking is the only bank making markets in them. Just 3,511 of the Eurex contracts had changed hands by June 25.

Mark Pengelly.

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