What's the difference between a credit curve steepener and flattener trade?

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AcadiFi · Accepted Answer

A credit curve steepener profits when the slope between long-dated and short-dated credit spreads widens. A flattener profits when that slope narrows. Mechanically, you buy protection on one tenor and sell protection on another. For a steepener on Aurelian Textiles, sell 3-year protection (receive 140bp premium) and buy 10-year protection (pay 240bp premium), with notionals scaled to be spread-duration-neutral. The net carry is negative but you gain if the 10y-3y spread differential widens from 100bp to 160bp. A flattener is the opposite: buy 3-year protection, sell 10-year protection. When do you use each? Steepeners work when the market is complacent about near-term default risk but you expect longer-term deterioration — often early in a credit cycle when spreads are tight across the curve. Flatteners work when near-term stress appears but you believe the firm survives; the front end widens more than the back end as the market prices imminent distress. Steepeners are essentially long convexity to credit stress; if the issuer defaults quickly, the short-end short protection position loses badly. Position sizing uses DV01 neutrality: match the basis-point-value of each leg. Our FRM Part I credit derivatives sessions include trade construction examples with P&L attribution under multiple scenarios.

What's the difference between a credit curve steepener and flattener trade?

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