Thursday, November 09, 2006

Of LBO, CDS and supply side ex-inflation

This post is brought to you by Economonitor.

First up, he mentions he has had second thoughts and concedes there may indeed be a benefit in having the CDS market serve as a hedge between the debt and equity markets. No sooner said than a commenter pops up with a third thought:
This is the same trade that everyone put on when GM was looking like it was going to be forced to enter chapter 11. Short Stock and short CDS to pay for it. With the stock dovetailing this looked like a perfect play. The problem was when the kerkorian bid/tender came in 3 points above the last tick. This event led to a spike on the equity side of the trade without a corresponding move in CDS to offset.

With increasing LBO activity this strategy becomes a double loser. If you have this trade on when the company gets a bid you lose on both ends. CDS spreads spike due to the flood of junk debt that will be used to finance purchase and the equity which you're short spikes.

If you want to pick up nickels in front of a steamroller using strategies like this then you'd be better off short OTM options against an index. At least that strategy only blows up on you every couple years versus everytime a stock gets a LBO bid.

At least his blog gets comments, one of which was actually a comment and not spam!

Next, he brings us the distressing news that practically all of the $140 billion increase since 2000 in investment by the oil and gas industry was eaten by inflation, so what on its face looks like expanding supply turns out to be barely keeping up.

Just how dismal is that "science"?


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