Right. CDS are institutional instruments, but even if hypothetically you can implement the trade and collect the premiums, you make money 99% of the time, but that 1% the time you're wrong you completely wipe out your net worth and then some. Think about AIG who sold cheap CDS on subprime debt to John Paulson.
Erm, actually, Greek restructuring was deemed a credit event and a CDS trigger. Greek sov CDS did pay out in the end.
You can't get the trade off, if you could it would be MTM taking out all the underlying under capitalized players -- think MF Global -- and, even if all of the above were not true, the premise of the trade is blind faith; never a good idea. I'm not trying to be a dick but if this is your approach to generating income from your capital you need to go back to square one. This is not even a starting point.
Thanks for the responses, folks! I'm not saying there's no risk. I just think that I don't need to worry about it in my lifetime. I still want to sell these, if possible. I understand that no one would probably want to buy these from me, due to counterparty credit risk, but maybe I can work something out where I start putting up money if the risk of a credit event occurring increases significantly? For example, it's pretty safe to assume that Australia won't default on its debt in the next 5 years. I get to collect premiums (30-40 bps? I know US is around 30 bps) till then and say something happened and the risk of default suddenly increases, I will be able to put up a lot more money to cover losses. Again, the real issue here is margining. I can't put up too much money in the beginning. This is not the same as selling CDS on mortgages. My broker friend who was making millions selling homes in California told me in 2005 that the party was about to be over. Shame on AIG for not seeing this.. I'm very comfortable betting my entire net worth on Australia not defaulting on its debt. lol, probably sounds a lot like what AIG was thinking back in 2006. Can I open a "Hedge Fund", get a prime broker account (I don't even know if I have enough money to get one of these) and then sell CDS? Anyone know anyone at a bank who I can talk to and figure out how much I will have to put up, and how much in notional I can sell?
This talk of the inherent risks are silly. OK, look at it as selling a 1Y put on a $1,000 single name at $3 in premium (0.03 per contract). The practical obstacles are insurmountable. Vick, do you have more than $10MM lying around? Is $30k good use of the $10MM? If so then I am sure you can open a PB with someone that clears Macquarie(?), or you can contact ISDA and they can help you out. wheeee. Can we close this now? Logarithmic at zero? Que?
You've nailed it - counterparty or C1 risk is the reason no one will buy from you... Trust me, the risk profile of all counterparties is scrutinized in depth, especially in this environment. This is the realm of the institutional players who can demonstrate the deep pockets required to make good. I work in asset/liability management for an insurer so I understand how they view risk profiles... As someone else alluded to - how could you fulfill your obligation should a credit event occur? If you could, then you should be sipping bordeaux in your palace in St Barts, not worrying about writing CDS. No offense, but even suggesting your position not be marked demonstrates that you should be staying far away. The modelling behind the marking of these contracts is fairly complex (not like standard equity or derivative positions) and you would need to monitor your positions diligently. At least the Greek situation actually triggered the swaps so that means that the CDS market is functioning somewhat correctly. If you want exposure, just wait for an ETF (if there isn't one already). I believe S&P tracks numerous CDS indices and since the average investor clearly wants exposure I'm sure someone will step up and fill that void.
No. Go open an IB account (I presume they offer ASX futures), buy Aussie 3y bond futures, sell a strip of IRs (or IBs). That's the closest you can get to sovereign CDS. Given that you don't seem to comprehend exactly what you're doing, I am pretty sure you're equally certain to lose money in either case. There is no way for anyone, institutional or otherwise, to trade derivatives without mark-to-market. To imagine otherwise is delusional. Let's not close pls... I am exceedingly eager to get to the bottom of this whole "logarithmic at zero" concept. I think bwol is close to revealing the most important advance the world of fixed income has ever known. Whatever you do, don't tell Bill Gross.
As Marti states, why not short Sov debt outright? Sell puts on futures on the Aussie 10s? Why the interest in something you can't possibly source? For a couple K you can sell some vol. The CDS question is akin to asking why you can't get some loan guarantees on a Ford Motor LBO.
Please don't just assume that I have no clue about how derivatives work. I'm not just making this post to troll this forum. I really am willing to take that risk and seeking advice on how I'd go about doing it. Please trust me when I say that I work in the derivatives industry and have an educational background in it as well. I just don't know much about the CDS world... Now that I think about it, dad said he'd give me $200K to invest/start a business, because he recently sold a lot of land. I refused his money cuz I had no use for it then, but I'd be willing to ask him for it... Assuming that my positions would be marked to market, how much in notional would I be able to sell with around 250K in capital? How does margining work. I'm assuming the "standard" contract size is 10 million? Assuming that the CDS on Aussie debt is trading at 50 bps, how much in initial margin would I need to come up with, for selling 10 million in protection? Any help is very much appreciated. When I was first making this post, I recalled Berkshire Hathaway selling puts on Equity Indices in 2008 without daily mark-to-market. I'm not saying that counterparties should view my credit risk just the same as Buffet's but maybe I won't have to put up as much capital and those yearly premiums will be significantly higher than the risk free rate of return on the capital I put up? Also, I'm not looking to go long those bonds. My goal is to take on as much of the default risk as I can, and none of the inflation risk etc... I also want to do it while putting up as little money as possible to maximize returns. I seriously don't think Australia will default on its debt anytime soon and willing to bet my life on it.
CDSs are contracts that are governed by the ISDA Master Agreement. You will need around $100k (rough estimate) to pay lawyers who will negotiate the terms with your counterparty. Once that is out of the way, for a naked short CDS position you can expect to post a minimum of arnd 10% of notional in initial margin. There is no standard contract size, but there are considerations of economies of scale for counterparties. In you case, I doubt it's worthwhile for a counterparty to get involved. Erm, just think about it. Warren Buffett doesn't have to mark-to-market, because the PNL volatility of his put position is a relatively tiny fraction of the capital available to him. Moreover, even in an extremely adverse scenario, Buffett's put position isn't likely to completely blow him up. Is all this the case for you? As to the yearly premia, Aussie 5y CDS is arnd 75 mid now. Does 0.75% sound like a return that is significantly higher than the risk-free rate of return on your capital? You didn't read what I said carefully enough. I didn't just suggest that you buy the bonds. I said that you should buy the bonds and sell a strip of STIR futures to construct an asset swap position, which is as close as you or I can get to trading CDS. Once you have a few hundred mil, however, things may change and your bank may be willing to offer you these products.