A credit default swap index is a standardised basket of single-name CDS on a fixed list of reference entities. When you buy protection on iTraxx Europe, you are effectively buying a portfolio CDS on 125 of the most liquid investment-grade European corporate names — all in one trade, at one spread, with one ISDA confirmation. The index trades as a single product with the liquidity of the whole market behind it.
iTraxx Europe
iTraxx Europe is the flagship European investment-grade CDS index, comprising 125 equally weighted European corporate names. It is divided into sub-indices by sector:
- iTraxx Europe Senior Financials (25 banks and insurance companies)
- iTraxx Europe Non-Financials (100 corporates across industries)
- iTraxx Crossover (75 sub-investment-grade or high-yield entities — the most actively traded of all)
- iTraxx HiVol (the 30 widest-spread non-financial names from iTraxx Europe)
The five-year tenor is the most liquid. The iTraxx Europe index spread (in basis points per annum) is the weighted average CDS spread of its 125 constituents and is the market's most widely quoted indicator of European investment-grade credit risk. When the iTraxx 5y spread widens from 60bp to 100bp, it means the cost of buying protection on a basket of European investment-grade corporates has risen significantly — a signal of deteriorating credit sentiment.
CDX North America IG
CDX.NA.IG is the North American equivalent — 125 investment-grade US corporate names, five-year tenor, traded in the US market. CDX also has high-yield variants (CDX.NA.HY), emerging market variants (CDX.EM), and other sub-indices. The CDX.NA.HY (100 US high-yield names) is often used by credit hedge funds for directional credit bets or to hedge high-yield bond portfolios.
Composition and Rolling
Both iTraxx and CDX are rolled every six months — in March and September. A new series (a new set of constituents) is published, and the previous series becomes "off-the-run." The composition process for each new series involves dealers nominating the most liquid eligible names; the final list is determined by consensus among the major dealer banks.
Names may be removed from the index between rolls if they experience a credit event (default, bankruptcy, or restructuring) — the constituent is settled out of the index and the remaining names continue with equal notional reweighting. Names may also be removed if they are acquired, downgraded to sub-investment-grade, or otherwise become ineligible.
The on-the-run series is the most recently rolled index — the most liquid, where most new trading flows. The prior series are off-the-run and trade at wider bid/offer spreads with lower volume. Off-the-run series remain important because many legacy hedges and structured credit positions reference them.
Index vs Single-Name CDS
A single-name CDS provides protection on one specific issuer. An index provides protection on the entire basket simultaneously. The index is more liquid and more efficient for taking broad credit views; single-name CDS are used when the investor has a view on a specific issuer or needs to hedge a specific bond position.
The theoretical relationship between the index spread and the individual constituent spreads is: the index spread should equal the weighted average of the constituent CDS spreads. In practice, there is a small deviation called the index basis — the difference between the index spread and the intrinsic value calculated from constituent spreads. When the index trades wider than intrinsic (negative basis), it means the index is cheap relative to the individual names, and arbitrageurs can buy the index and sell individual constituents. This basis-trading activity keeps the index aligned with fair value.
Tranched CDS Index Products
CDS indices can be tranched — sliced into layers of risk, analogous to securitisation tranches. The most common tranched iTraxx products are:
- Equity tranche (0-3%): absorbs the first 3% of losses in the index. Very risky — any defaults hurt this tranche immediately. Investors receive a very high spread or upfront premium.
- Junior mezzanine (3-6%): protected from the first 3% of losses, exposed to the next 3%.
- Senior mezzanine (6-9%, 9-12%): increasingly remote loss probability.
- Super senior (12-22%, 22-100%): only suffers if a large number of index constituents default — very low probability, very low spread.
Tranched index products allow investors to express views on the correlation of defaults — not just the average credit quality of the basket. The equity tranche is exposed to idiosyncratic (single-name) default risk; the senior tranche is exposed to systemic default risk (many names defaulting together). During the 2008 financial crisis, super-senior tranches that were priced as near-riskless experienced unprecedented losses as correlations spiked — a structural failure in the tranching model that was central to the crisis.
Using CDS Indices for Macro Credit Views
CDS indices are the fastest and most liquid way to implement macro credit views. A hedge fund that believes a European recession will widen credit spreads can buy iTraxx Crossover protection (pay the spread, receive it if spreads widen or defaults occur). A bank that has extended corporate loans and wants to hedge its credit book can buy CDX.NA.IG protection as an overlay.
The iTraxx Crossover index — sub-investment-grade European names — is particularly active and is often quoted by credit strategists as the barometer of credit stress in Europe, analogous to the VIX for equities.