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Corporate Quantitative Weekly

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Corporate Quantitative Weekly Corporate Quantitative Research New York May 12, 2006 In the U.S., this report is available only to persons who have received the proper options risk disclosure documents Corporate Quantitative Weekly 1. Capital Structure Page 3 A framework for comparing CDS and PCDS, and some relative trade recommendations The PCDS-CDS relationship reflects differences in both default risk and recovery value in default between the two products. This relationship appears out of line for several companies in the banks, broker, REIT and insurance sectors. Off the charts: Equity performance suggests GMCo CDS should trade through Ford Co GM CDS has outperformed Ford CDS recently, but a comparison to the equity markets suggests that this out-performance has further to go. GM 1yr CDS spread is out of line with the rest of the GM curve, but is explained by the CDS/equity option relationship The General Motors CDS curve is inverted, except for the 1Y tenor, because investors are selling CDS protection to fund the purchase of puts, in our opinion. Corporate Quantitative Research 2. Credit Derivatives and CDX indices Page 15 Eric Beinstein AC Credit derivatives market commentary (1-212) 834-4211 IG6 widened by 2bp, reversing the rally that began in March. IG basis to theoretical [email protected] suggests the CDX will rally, or the underlying CDS will widen. Wilson Er (1-212) 622-3733 3. Equity Derivatives Page 18 [email protected] Strategies for near term uncertainty in homebuilders Ben Graves, CFA We look to profit from a bullish view on homebuilders over the medium term, with (1-212) 622-4195 potential volatility and downside risk in the near term, by buying puts, buying put [email protected] spreads, and selling calls. Katy Le (1-212) 834-4276 Off the charts: Options screening tools [email protected] Both ADM and XMSR have both established new one-year-highs in 12M implied Alex Sbityakov volatility, and have relatively high implied volatility over realized volatility. (1-212) 834-3896 [email protected] 4. Structured Credit Page 24 Andrew Scott, CFA Introducing Index Tranche Option Daily Analytics (1-212) 834-3843 This report provides analysis of CDX and iTraxx tranche options, showing daily [email protected] option prices, breakevens and implied volatilities using our CDS pricing model. The certifying analyst(s) is indicated by a superscript AC. See page 46 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Customers of JPMorgan in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research. Eric Beinstein (1-212) 834-4211 Corporate Quantitative Research [email protected] May 12, 2006 Previous Articles and Recommendations* Please click on articles below for the previously issues 1. Capital Structure Date Date What can unsecured CDS tell us about where LCDS should trade? May 05 Goodyear Tire & Rubber: Buy stock, buy 5Y CDS protection February 03 Sell CDS protection to fund long volatility position in KB Home April 21 Monetize cross market views on default through CDS & equity puts January 27 Ford stock and CDS spreads move out of line April 13 Lear: Buy stock, buy 5Y CDS protection January 20 Sell S&P puts and short risk CDX March 24 Maytag: Equity call options to capture upside from WHR merger January 13 Owens-Illinois: Buy stock, buy 5Y CDS protection February 17 HCA Inc: Implement credit view through equity puts and CDS January 06 Trends in Homebuilders February 10 2. Credit Derivatives and CDX Indices Date Date CDX vs. Cash - CDX outperforms recently. May 05 Early preview to the CDX Series 6 launch February 24 Trading in CDX HY across the curve began. IG 5-10yr may flatten April 28 Analyzing the bond/CDS "Convexity Trade" in Autos February 24 Sell CDX HY straddle and buy CDX XO straddle April 28 CDS-bond basis remains tight. CDX basis gives mixed messages February 17 Two B or single B? April 21 High Yield CDX: the three year tenor now trades February 10 Auto basis and curve trade opportunities April 13 CDS documentation innovation: net physical settlement February 03 Sell June strangle on CDX.NA.HY 6 100 Swap April 13 CDS-bond basis in High Yield has been steady, unlike IG February 03 Introducing Credit Default Swaps on Secured Loans (LCDS) March 31 Bond and CDS diverge - basis is near record tight levels January 27 Post the Series 6 launch, CDX basis increases March 31 Profiting from views on recovery rates January 20 Preview to HY CDX roll March 24 Calpine Corp: CDX cash settlement auction result January 20 Trading Credit Curves I & II March 24 Curve trading opportunities in GMAC January 13 CDX IG and XO Series 6 launch review March 24 Sell March straddle on CDX.NA.XO.5 January 13 CDX Series 6: preview to launch March 17 Calpine Corp: CDX cash settlement protocol mechanics January 13 CDX IG and CDS rally while JULI stands still March 17 CDX near-term outlook: Current themes in CDX & 2006 outlook January 06 Credit Default Swaps on Preferred stock (PCDS) March 17 CDS valuation: Curve shape & recovery rate assumption impact January 06 Dana Corp: CDX cash settlement protocol March 17 Sell March strangle on DJ CDX.NA.HY.5 100 Swap January 06 CDX Series 6 portfolios are announced March 10 Calpine Corp: CDX cash settlement protocol update January 06 Curve trade opportunies March 10 3. Equity Derivatives Date Date Volatility pairs: Identifying the exploiting dislocations May 05 Sell TOL 3M $35 call to finance long PHM 3M $40 call February 10 Pre-earnings single stock volatility outlook April 13 Buy Sprint Nextel (S-OW, Focus List) Jan 07 30 call options February 03 Introducing equity derivatives dailiy market screening tools March 24 Energy stocks: Four strategies to play rising uncertainty January 27 Sell Tyson Foods (TSN) Apr 06 12.50 straddles March 10 Reduce downside risk in Caterpillar: Use costless collars January 20 Synthetic dividend exposure to our "dividend surprise" portfolio February 24 Long XTO Energy and short Chesapeake Energy January 13 General Motors Corp (GM): Sell a June 06 22.50 straddle February 17 Altria Group Inc: Use risk reversal overlay to execute bullish view January 06 4. Structured Credit Date Date Unlocking Junior Mezz: Opportunities in 3-5% & 5-7% tranches April 28 Trading CDX tranche forwards February 03 Two B or single B? April 21 Tranche(let) Top Trumps February 03 Introducing options on tranches April 13 Mining for value in CDX tranchlets January 27 The CDX Tranche Roll Reloaded March 24 CDX tranche market themes and recommendations January 20 Roll-Lite: Preview of CDX.IG.6 Tranche Roll March 17 An introduction to tranchlets January 13 Accounting for Credit Events in CDX.HY tranches March 17 Effect of the new S&P Syn CDO ratings model on CDX tranches January 13 Reading between the lines: the CDX tranche chartbook February 24 Positioning for event risk more attractive in the 10Y tenor January 06 CDX tranche relative value roundup February 10 5. US Quantitative Equity Strategy Date Date Rebalancing our Factor Model May 05 Revisiting Dividends February 24 Cautious Optimism April 13 Heavy Lifting February 03 2 * Corporate Quantitative Weekly are also avaialble on our JPMorgan Chase Website www.morganmarkets.com. Click on the "Credit" tab, then on the "Credit Derivatives" button located in the dark blue bar. Previous publications are listed in the "Flagship Research" section. Eric Beinstein (1-212) 834-4211 Corporate Quantitative Research [email protected] May 12, 2006 Capital Structure A framework for comparing CDS and PCDS, and some relative trade recommendations • The PCDS-CDS relationship reflects differences in both default risk and recovery value in default between the two products. This relationship appears out of line for several companies, based on our assumptions of recovery rates in both products. • For the banks that trade in the PCDS market, we believe that the PCDS- CDS spread difference is too wide given our view that a PCDS deferral without a CDS default is very unlikely. • The broker PCDS-CDS relationship also appears too wide. • In REITs, we believe that the PCDS-CDS spread difference is too narrow as these companies are more likely to have a PCDS deferral without a default, and PCDS recoveries will be significantly lower than the very high recoveries likely on CDS. • In insurance, a couple of companies are in line, while the PCDS is too wide to CDS in the others. • We recommend several trades based on these views. Introduction Preferred CDS spreads (PCDS) should trade at a wider spread than regular CDS due to: 1. the possibility that there is a credit event in PCDS without there being a simultaneous credit event in regular (unsecured) CDS 2. the likelihood that in a simultaneous PCDS and CDS credit event, the PCDS deliverables would trade at lower prices than CDS deliverables (i.e., preferred stock would trade at a lower price than bonds or loans due to its lower status in the capital structure) In the market, we observe that PCDS spreads are wider than CDS spreads, in some cases significantly so and in others less.
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