Credit Indices

Credit indices let investors trade or hedge the credit risk of a broad group of companies in one transaction. The most traded are CDS indices, CDX in North America and iTraxx in Europe and Asia, which bundle credit default swaps on 100 or 125 companies. Bond indices, such as the Bloomberg US Corporate Index and ICE BofA indices, track the performance of corporate bond markets and serve as benchmarks for funds. Credit indices are watched as real time gauges of credit market stress.

CDS indices#

The indices are administered by S&P Dow Jones Indices (CDX) and S&P (iTraxx, formerly Markit). Each name usually has an equal weight.

How an index CDS works#

Trading an index CDS is like trading CDS on all the companies at once:

• Buying protection: pay the index coupon; receive compensation if any company in the index has a credit event (proportional to its weight).
• Selling protection: receive the coupon; take on the credit risk.

Investment grade indices are usually quoted as a spread in basis points; high yield indices are quoted as a price, such as 104.5, around a fixed coupon. See Credit Default Swaps (CDS).

Rolls and series#

CDS indices roll every six months, in March and September. A new series is launched with an updated list of companies, removing those that have been downgraded (for investment grade indices) or have become illiquid. Most trading moves to the new "on the run" series. Older series continue to trade with their original names. See Rolling Futures Contracts for the similar idea in futures.

Index tranches#

Index tranches split the credit losses of an index into slices, such as 0% to 3%, 3% to 7% and so on. Equity tranches absorb the first losses; senior tranches are hit only after large losses. Tranche prices depend on default correlation, the same concept that was mispriced in mortgage CDOs before 2008. See Default Probability and Recovery Rate.

Bond indices#

Bond index spreads, such as the ICE BofA US High Yield option adjusted spread, are widely used to track credit conditions. See Credit Spreads.

How traders use credit indices#

• Macro hedging: buy protection to hedge credit or equity portfolios in a downturn.
• Expressing views: sell protection to gain broad credit exposure.
• Relative value: investment grade vs high yield, North America vs Europe, index vs single names (the index "skew").
• Signals: sharp moves in CDX HY or iTraxx Crossover often accompany equity selloffs.

Risks#

• Basis risk between the index and a specific portfolio.
• Jump risk from defaults of index members.
• Liquidity in off the run series and tranches.
• Correlation risk in tranches.

Frequently asked questions#

What are CDX and iTraxx?#

Credit default swap indices that bundle CDS on 100 to 125 companies in North America (CDX) and Europe or Asia (iTraxx), letting investors trade broad credit risk.

How often do credit indices roll?#

CDS indices launch a new series every six months, in March and September, updating the list of companies.

What is a credit index used for?#

Hedging credit portfolios, taking broad credit views, relative value trades and tracking credit market conditions.

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