Peter Tchir of TF Advisors gives some color on the JPM Trade.
We have talking about what may or may not have happened at JPM for the past week, and by “we” I mean the entire market. We do not know the exact nature of their trades, but as far as we can tell from what we read and the rumor mill, JPM had a series of complex trades, though the overall ideas seemed to be “short high yield” and cover the costs by being “long investment grade” with a particular emphasis of jump to default risk over pure spread risk (though spread risk played a big part).
They were short various XOVER and HY indices, both outright and in tranche form. They were long various IG indices, both outright and in tranche form, though with a few additional curve trades to manage the jump to default risk.
We have tried to estimate the scale of the positions by asking “how much would JPM want to make if HY sold off 10%”. Using that, and a guess of $5 billion, it gives you a reasonable guess that the HY short had to be the “delta equivalent” of $50 billion. The term “delta equivalent” is important, because a $1 billion move in the index, can have a “multiplier” effect on the price move in the tranche. In general, the first loss tranches will move much more than the index, so a $1 billion position in a tranche can behave like a $10 billion index position. A bit confusing but if you think of it if terms of how a “deep in the money” an “at the money” and a “way out of the money” option react to the price moves of the underlying stock, it is somewhat similar.