CDS understanding

Yes this is right. I nearly got confused myself!

Can be confusing but in the CDS world, as the concept of long/short seems “inverted”.

Let me explain my line of thought to remember:

It may sound confusing because we think Buy Protection = Long, Sell Protection = Short.

In finance, going long means we benefit when “something” improves and going short when something deteriorates. In CDS world this is the same concept, and this “something” is credit quality.

So, when we buy (sell) protection we actually hope that the credit quality will go down (up), so we can benefit from the trade. That means when buying protection we hope credit quality will deteriorate, and selling protection – credit quality will improve.

To conclude:

Buy Protection => Credit Quality to deteriorate = Short Position Sell Protection => Credit Quality to improve = Long Position

In my opinion, Credit Default Swaps (CDS) are a useful but complex financial instrument. The role of CDS is as a form of credit insurance to help investors manage risk, especially in the debt market. However, it is important to understand how long and short positions work because they are not the same as traditional positions, especially since “long” is actually selling insurance, and “short” is buying insurance.

You can unwind this position by selling the CDS at a higher price if the credit quality improves, or you may hold the position and continue earning premiums until expiration <span class=”atwho-query”>@slope</span>