10-15% CDX IG tranche optimal for naked long bets, says Barcap

In its latest US Structured Credit Weekly research, Barclays Capital says the 10-15% is curently the optimal CDX IG choice among senior tranches for investors to go naked long. The bank finds that, using maximum leverage, this tranche has the best risk-adjusted return, the highest average return and the lowest standard deviation. Moreover, the probability of a forced unwind if mark-to-market P&L falls below -50% is lower than 20% - almost half the probability of the 15-30% or 30-100% tranches.

Barcap's analysts simulate tranche spreads to compare the mark-to-market volatility of the three senior-most tranches with no delta exchange. To generate tranche spreads, they first simulate five-year IG index spreads using daily volatility of 5.75%, consistent with historical levels. The change in the tranche spread is calculated as the sum of the index-implied move and a random term capturing the delta-adjusted move - estimated for each tranche using historical data.

Barcap assumes that the trade is held for 20 business days, after which P&L is realised. The trade is, however, unwound if leveraged mark-to-market P&L exceeds 50% or falls below -50% at anytime during its life.