ABX protection buyer

[ajsa]

Hi David,

I wonder if ABX protection buyer shorts ABX? If so, if there is any credit loss, the protection buyer will compensate the buyer, and meanwhile the ABX price also drops, so the ABX protection buyer who shorts ABX also gains.. is this a double-dip? or I misunderstand something?

Thanks.

 

[ajsa]

Hi David,

Could you please take a look this question when you get chance?

Thanks!

 

[David Harper CFA FRM]

Hi asja,

As I understand (maybe I do not fully), the ABX is a basket CDS (i.e., where the reference is a basket of 20 tranche-equivalent MBS; e.g., BBB MBS tranches): the protection buyer is (synthethically) shorting the underlying reference (i.e., gets paid on defaults) and the ABX protection seller is long the underlying (i.e., hopes the ABX price maintains/increases so he/she collects the premiums without making payouts). So, I only understood the: protection buyer & seller...I am not aware of there is another way to "short" the ABX (aside from buying protection)...it's not clear to me why that would be useful, anyway, as the protection buyer already gets to express an unfunded short view
... of course, the counterparties could still engage in arbitrage via the underlying and CDS on the underlying MBS

David