Credit Default Swap Market Needs Transparency, Still a Good Signal

Wikipedia Definition of Credit Default Swap:

"A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument - typically a bond or loan - goes into default (fails to pay). Less commonly, the credit event that triggers the payoff can be a company undergoing restructuring, bankruptcy or even just having its credit rating downgraded."

Ever since Bear Stearns, Fannie, Freddie, Lehman Brothers, Merrill, Citi and AIG blew up in 2008 (which all started when two Bear Stearns structured product hedge funds blew up in June 2007 pre-Gov bailout: Bear Stearns Tells Fund Investors `No Value Left' -Bloomberg), credit default swaps were supposed to insure against losses on defaults but instead brought down the whole financial system (AIG Trading Partners Squeeze Insurer Before Bailout Bloomberg June, 09). The Lehman Brothers bankruptcy put the nail in the coffin (Lehman CDS Settlement Disappoints - WSJ) and taxpayers ended up being the credit default swap. Here's a great article from Financial Sense on June 6, 2008 predicting the CDS crisis (CREDIT DEFAULT SWAPS THE NEXT CRISIS by Financial Sense) and Time also had an article. Also Soros warned about CDS in early 2008 in the Financial Times (more below) and Warren Buffet wrote in Berkshires 2002 shareholder letter that they were "financial weapons of mass destruction".

So now that the Government intervened. How the hell do we fix the credit default swap market so it will actually protect from defaults during the next credit crisis and not bring down the whole financial system. Recently the Senate Banking Committee held a hearing on Over-the-Counter Financial Derivatives Regulation (Cspan). It was a very interesting hearing featuring a bunch of CDS wizards. It also featured Ken Griffin of hedge fund Citadel who is starting a CDS clearinghouse with CME Group. They talk about dealers, transparency, valuation risk, illiquidity, capital and margin requirements, systemic risk and exchanges.


Soros also warned about credit default swaps in April, 2008 (The false belief at the heart of the financial turmoil FT.com). A year and 3 months later, Soros thinks they should be banned (Ban CDS as "instruments of destruction" - Soros - Reuters).



I think if credit default swap spreads were more transparent and exchange based they would definitely benefit the public interest. CDS activity could be used by the public to monitor the health of a company or sector. An individual investor, institution, hedge fund or corporation can sense trouble if traders are bidding up CDS to protect from default risk. Analysts even use CDS activity to price out bonds. I'm not a pro on credit default swaps, but I think if used properly they can be used as a market signal and a way to hedge risk.

Markit.com provides credit default swap indices and charts and a free CDS Portal offering credit event details, spread movers (wideners/tighteners), CDS News and indices. This information is compiled from various dealers.

Articles/Past Posts:
Credit Default Swaps Should Be Regulated As Insurance (Reuters/InsuranceJournal)
Credit Default Swap Index, ABX, CMBX Technical Analysis (9/16/08)
An Idea To Prevent The Next Credit Default Swap Illiquidity Crisis (10/5/08)
Credit default swaps and derivatives explained (60 Minutes, CSPAN videos) (11/08/08)
Credit Default Swap Spreads Still Elevated (3/31/09)

We Have a Recovery on the Way!

Another economic update from Walstreetpro2. Go to his youtube channel.

SPY Pierced Head and Shoulders Neckline (Chart Update)

The $SPY head and shoulders neckline was pierced. I'd be cautious here and see how it closes. Let the BOTs fight it out.



Here is a chart of the close from Stockcharts.com. It pierced the neckline but closed above it with 200 day moving average support. Judgment day is coming.



Related:SPY Put/Call Volume Ratio Low vs. Open Interest (July 7, 2009)
IYR, SRS Real Estate ETF Chart H&S Observations (July 2, 2009)
SPY Head and Shoulders Chart Pattern, Watch 875 Neck Line (June 28, 2009)

Rosenberg: Secular Bear Market at Halfway Point (CNBC Video)

David Rosenberg, former Merrill economist now at Gluskin Sheff was featured on CNBC. Here is the video and a summary of his thoughts.

• 40% dead cat bounce from March to May
• 6 points of multiple expansion during rally, not earnings driven
  
• Consensus: $75 operating earnings per share priced into 2010
• At best we'll see $50 this year in S&P earnings
  
• Equities are pricing in an earnings recovery we won't see until 2012
• $50 in EPS + 13-14 multiple = $675ish... (So, retest?)
• Another fiscal package won't save the day
• Had 18 Year bull market (1982-2000), we move in 18 year cycles..
• Halfway through secular bear market in equities, w/ two price peaks (wow)
• There will be huge spasms along the way, you can't be a buy and hold investor!
  

SPY Put/Call Volume Ratio Low vs. Open Interest

Look at the difference between SPY put/call open interest ratio and put/call volume Ratio via Schaeffersresearch yesterday. The $SPY put/call open interest ratio was at monthly highs and put/call volume ratio was at monthly lows. At 7/6/09 close the SPY put/call open interest ratio was 1.83 and the 21 day SPY put/call volume ratio was 0.77. The last time we saw 0.77 was when SPY sold off from 89 to 68 (March 2009 lows). Look at the chart. The sentiment reading could totally flip to be contrarian in nature though. So traders are loading up on puts vs. calls but trading more calls vs. puts (21 day average? from Schaeffers). So will volume rush into puts to make put holders money? The VIX has been in a range since May (24-33) so a put premium volume spike would need to occur, or a big complacent SPY sell off.

SPY Put/Call Volume Ratio (schaeffersresearch.com)

SPY Put/Call Open Interest Ratio (Schaeffersresearch.com)

$SPY is down 1.34% as we speak and there are technical levels near by that could CRUSH the S&P if broken (June 28: SPY Head and Shoulders Chart Pattern, Watch 875 Neck Line). A head and shoulders neckline breach would bring in sellers. I'm thinking this is why traders/institutions are speculating or hedging with puts imho. You never know though. In May the put/call open interest ratio hit monthly highs while the market kept rallying, so those contracts were ripped up or a big fund pocketed some nice premium if those puts were sold-to-open (SPY May Put Pessimists Squeezed, Contracts Ripped Up).

$SPY Head and Shoulders Pattern?
Also here is Art Cashin of UBS on CNBC giving more insight on the S&P head and shoulders pattern and 877 level.

Oil Put in a Double Top -Credit Suisse Sneddon (7/6/09)

Reported from BloombergTV today (7/6/09). Credit Suisse technical analyst David Sneddon said oil put in a "double top" today. "Double tops signal the trend is changing. Oil prices stalled out at roughly the same price over the last month". Sneddon sees $59 as the first support level with a potential break to $57.75.


If he's right, the players who hedged or bought all those out-of-the-money XLE and USO puts on June 23 could bank some fiat $$. (Read: August $USO, $XLE Put Options Active). $DUG will also perform well if oil continues to fall (UltraShort Oil & Gas $DUG Testing $20 Resistance July 6).

This is also a must read: Verlerger on Oil Glut: "There has never been anything like it", Sees it at $20/barrel (Naked Capitalism)

Goldman Sachs Program Trading Code Stolen

I thought this may be of interest. According to Reuters and Zero Hedge (must read), Sergey Aleynikov, a former Goldman employee, was arrested for allegedly stealing Goldman's secret program trading codes. He uploaded them onto a German website registered by a person in London. The complete affidavit can be found at those two articles (PDF). Was this dude a quant spy? Goldman code stealer by day and professional dancer (h/t Reuters) by night? We shall see.. The story is kind of a mix between Hackers, Pi, Wall Street and Office Space. If he gets off for "accidentally" stealing Goldman's proprietary code, he should definitely play the lead role in Wall Street 3. Here's more from Bloomberg: Goldman Sachs’ Investment in Trading Code Put at Risk by Theft.

“The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,” Facciponti said. “The copy in Germany is still out there, and we at this time do not know who else has access to it.” (Bloomberg)