Selling/Buying Risk

[sprmario]

I was reading the below quote today in an article and it got me to thinking if there was a way to take advantage of the lower than normal spread between treasuries and all sorts of inferior debt. The article is saying that people are effectively overpaying for risk.

Anyone have any suggestions on how to basically short risk and long safety (ie, bet that the spread between treasuries and other bonds will once again widen) without
using derivatives. I'd also be interested on suggestions on how to bet that the spread between short and long debt will widen.

[ QUOTE ]
The spread, or additional yield, on low-quality corporate bonds ("junk") relative to Treasuries is at its lowest level in many years. Same goes for spreads on emerging-market bonds, which are at their lowest levels since 1998. As bond guru Bill Gross pointed out in a recent commentary, "When one can buy a U.S. agency guaranteed FNMA mortgage at a higher yield than almost all emerging-market debt, there exists an irrational pricing of credit."

Investors in these risky types of bonds are currently not getting paid very much in additional return for the risk they're incurring, which means that either a) they're so hungry for yield that they'll buy the bonds despite irrational pricing, or b) they think the future will look as rosy as the present. The first answer smacks of investors who fear being "left behind" by their peers, while the latter points to recency bias, which gets investors into trouble time and time again.

In fact, one could argue that the current extremely low yields on just about all types of long-term debt reflect a market that's not terribly worried about the risk of inflation eating away those returns down the road. There are other factors at work in keeping yields low, of course, but it's an interesting thought.

[/ QUOTE ]

[Groty]

Although not a perfect proxy for your objective, a "pairs trade" may come close to providing the exposure you want.

For example, going long the IEF (an ETF that will give you exposure to intermediate maturity U.S. treasuries), and simultaneously shorting the DSU (an ETF that gives exposure to U.S. corporate credit).

This trade would isolate credit risk and give you the exposure you want. However, I'm not sure how these ETF's handle interest, so you may end up being net short interest on the trade. And I'm sure the average maturities of each aren’t perfectly identical, so you’d have a duration mismatch.

[hawk59]

CDS are instruments that price debt based on their spread over treasuries. But I doubt you'd be able to get into anything like this on an individuals budget. I don't what kind of ETF's they have these days but you could find a Treasury ETF and buy that and then short a corporate debt ETF. Also, there might be a security out there that tracks the VIX index(Volatility Index). The VIX would spike as spreads blew out.