Negative basis hell
There have been a few posts around recently about losses on negative basis trades. These were apparently (one of) the source(s) of Merrill's recent loss. But I had not seen a convincing explanation until I came across this post from Zero Hedge. This picture is particularly eloquent:
At the time of the Lehman bankruptcy, it shows the spread had blown out over a thousand basis points. Now, given there is little liquidity in this stuff, Merrill is unlikely to have taken most of the trades off. So if this is the main cause of the losses, they will come back as the basis gets back to normal.
At the time of the Lehman bankruptcy, it shows the spread had blown out over a thousand basis points. Now, given there is little liquidity in this stuff, Merrill is unlikely to have taken most of the trades off. So if this is the main cause of the losses, they will come back as the basis gets back to normal.
Labels: CDS, Negative Basis Trade
posted by David Murphy at 22:12
2 Comments:
Hi David, I'm still a bit dubious that this is really the reason for the Merrill blow-up. Looks more like a convenient excuse to me. Given that much of this has since come back how come we were not given assurances that the losses were temporary and have mostly been reversed by the time the results were announced?
I share your scepticism, Tim: I'm not convinced at all that this was the main cause. But it is interesting how large the blowouts in the basis were. I guess we have to wait for Q1 2009 from BoA for some more insight.
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