Morgan Stanley recommends selling straddles, as credit implied vol lags the Vix

In a research report entitled “The Vix versus credit volatility”, Morgan Stanley points out that all-time-high equity implied volatility has not been matched by credit option implied volatility. CDX December 08 at-the-money implied volatility is 125%, or 10.2% in terms of implied price volatility. The researchers' reasons for credit implied volatility to lag equity implied volatility include the fact that investment grade credit is cheaper than equity on an absolute basis, and the fact that the Tarp plan is positive for investment grade credit but not necessarily for equity.

The report recommends selling straddles for investors who are net neutral to net short credit and who have other forms of convexity in their portfolios. An example would be to sell 1.7 times March 09 iTraxx Main series 10 payers with a strike of 170bp and buy one times March 09 iTraxx Main series 10 payers with a strike of 120bp. The trade costs nothing if the index ends up below 120bp, and generates its maximum profit if the index touches 170bp. It loses money only if the index widens beyond 240bp.