Barcap says sell 5yr 10-15% protection

In a recent report, Barcap’s strategists recommend the selling of five-year IG.9 10-15% protection and delta-hedging (0.3x) with the seven-year 3-7% tranche in the short to medium term. With acute concerns regarding potential unwinds and restructurings of trades referencing Lehman Brothers, WaMu, Freddie Mac and Fannie Mae, Barcap foresees the widening of mezzanine tranches. As a result, five-year 10-15% tranche is preferred for its limited exposure to widening technicals.

In terms of the LCDX10 index, a comparison of junior tranche performance revealed that buying five-year LCDX.10 5-8% protection has attractive P&L profile from a buy-and-hold perspective. Accordingly, Barcap recommends selling super-senior protection in a DV01-neutral form to fund the short 5-8% leg.