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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: forceOfHabit who wrote (56407)	9/15/2006 9:27:02 PM
From: YanivBA	Respond to of 116555

Tell me if I got it right now. If I short a put and short a stock my bet is really that the stock price would not rise above the strike plus the option premium because above that I am losing. Translating that into debt/equity would mean that I would be long bond / short stock and would hope enterprise value would not rise much above the value of outstanding debt (plus the interest earnings which serve as the premium ?). I believe most CDS traders would think that a selling of default protection and a short stock position is just a leveraged version of the above trade. It's not. Here is one reason: They might be surprised to find that they are being sued for the protection on technical basis while the company lives on. To complicate matters even more I believe many of the protection sellers are fraudulent and will never have the capital to pay in case of a real default. I think some of the short open interest on the financials has to do with this. Another way to look at it is to see that to buy volatility one can buy default protection and hold stocks. But this is also a very risky trade because you can not claim CDS protection unless you have a bond to deliver and there are more CDS contracts out there then bonds. This situation is very complicated. Basically at some point I believe the CDS market will collapse. The cracks are showing. However in the short to medium term the collapse of the CDS market could take stocks higher as much as it could take stocks lower. This technical default problem suggests a contraction of supply. The counter party and over saturation problems suggest a contraction of demand. The correlation with bonds and stocks should brake at some point. In the longer term leverage will have to go down. That is a credit contraction and should be bearish for everyone involved. Except lawyers of course. YanivBA