CDS Index
Also known as: CDX, iTraxx
Default protection on 100+ names in one trade — the S&P 500 of credit risk.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A credit default swap is insurance against one company failing to pay its debts. A CDS index packs a long list of those into a single contract. The two main ones cover 125 solid companies each: CDX.IG in North America and iTraxx Europe. The riskier versions cover 100 shakier borrowers.
One trade insures the whole list at once — or sells that insurance to somebody else. The price of the index is the market's temperature reading on credit. Around 50 basis points a year means calm. Around 150 means worried. In the worst of 2008 the risky index reached 800, which is a market that expects a lot of companies to fail.
Trading the index is far cheaper and far quicker than trading 125 separate contracts. So it is where a view on credit shows up first: what a fund manager buys when they think a recession is coming, and what they sell when they think it is not.
- Asset class
- Credit derivatives
- Instrument type
- Index swap on a CDS basket
- Traded
- OTC, cleared, extremely liquid
- Typical users
- Credit funds, banks, macro traders
3 · IntermediateHow it works in practice
How the machinery runs
- The roll: every March and September a new "series" starts with an updated constituent list (fallen angels out, new names in). Liquidity concentrates in the on-the-run series.
- Fixed coupons: 100bp (IG) / 500bp (HY) running, difference settled upfront — same convention as single names.
- Defaults: when a constituent has a credit event, its slice pays out via auction and drops from the index; the contract continues on the survivors with reduced notional.
- Versions: HY trades on price (like a bond), IG on spread — a market-convention quirk.
The ecosystem on top
- Index options ("swaptions on credit"): payers/receivers on the index — the liquid market for credit volatility and crash hedges.
- Tranches: the index sliced into loss layers (0–3%, 3–7%, …) — standardised synthetic CDOs that trade correlation.
- The skew: index spread vs. the average of its constituents' single-name spreads; arbitrageurs trade the difference.
4 · AdvancedPricing & valuation
Pricing and the intrinsic skew
The index's fair value is the duration-weighted aggregate of constituent hazard curves; deviations define the skew:
What the symbols mean
- nhow many periods, or how many things
Persistent skew reflects macro-flow demand for the index vs. idiosyncratic pricing of names, plus transaction-cost bounds on the arbitrage (trading 125 names). Skew trades package the index against a replicating single-name portfolio.
Index options
Quoted on forward spread/price with Black-style models; the subtlety is front-end protection — the option must account for defaults between trade and expiry (the "no-knockout" feature), handled via the FEP adjustment. The credit vol surface's skew prices systemic gap risk, and its steepness is a monitored stress indicator.
Tranche correlation
Tranches on the index reprice the loss distribution's shape: equity tranches long idiosyncratic risk/short correlation, seniors the reverse. The market quotes base correlations per detachment; their movement decomposes market moves into "average spread" vs. "systemic-ness". The 2005 correlation unwind and 2012's "London Whale" (massive IG9 tranche positions) are the market's cautionary tales.
Risk usage
Index CS01 hedges portfolio beta cheaply, but leaves single-name basis and curve residuals — quantified via regression hedge ratios (empirical beta of portfolio spread to index spread, typically > 1 in selloffs).
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.