What are CDX and iTraxx indices and how do investors use them?

Question

AcadiFi · Accepted Answer

CDX and iTraxx are standardized credit default swap indices that provide diversified exposure to credit risk across a basket of reference entities. CDX covers North American issuers (CDX.NA.IG for investment grade with 125 names, CDX.NA.HY for high yield with 100 names), while iTraxx covers European (iTraxx Europe Main 125 IG names) and Asian markets. Each index is administered by Markit (now part of S&P Global) and rolls every six months — a new 'on-the-run' series launches in March and September with updated constituents.

Consider Harlow Pension Fund hedging a $200M IG corporate bond portfolio. Buying CDX.NA.IG protection on $200M notional provides macro credit hedge at the index spread (say 75 bps). The quarterly premium is paid on remaining notional after any constituent defaults — if two names default, notional reduces by 2/125 × $200M = $3.2M, and Harlow receives (1 − recovery) on each defaulted name via auction.

Portfolio managers use indices for: (1) efficient macro hedging without picking single names, (2) expressing views on credit cycle (long/short via index spread), (3) basis trades comparing index spread to theoretical spread of constituents, (4) relative value across regions. Liquidity in on-the-run indices far exceeds single-name CDS, making them the workhorse of credit markets.

The index spread typically trades tighter than the theoretical average (the 'skew') due to supply-demand dynamics and convexity adjustments — a key CFA topic.

What are CDX and iTraxx indices and how do investors use them?

Master Level II with our CFA Course

Related Questions

Practice Questions