Expecting corporate debt to multiply this year, derivative investors are looking for the best strategies to go short on credit based products. "This year the story will be about default risk and recovery risk more than volatility," said Albert Gallo, managing director for credit derivatives strategy at Bear Stearns. "This is what investors told us in a (December) survey", with 88% saying they were concerned about defaults in 2008. As per a Reuters poll, speculative-grade defaults globally are forecast to reach 3.8%, up from a historically low 1.2% in 2007. While Royal Bank of Scotland forecast 10% defaults. "What is the best way to short credit over the next three to six months? This is a question we have been asked repeatedly in recent days," Lehman Brothers analysts wrote in a recent note.

Buying protection on a market index via a credit default swap seems to be the simplest way. Long CDS trades has been profitable so far this year as spreads have widened on fears of a U.S. recession, however it lost money last week. Strategists specializing in complex credit products suggest more sophisticated ways like buying protection on standardized index tranches.

 

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