Comparing Equity Put Volatility with Bond or CDS Spreads

Summary

The document outlines a relative-value signal for capital structure arbitrage, where a trader compares a company’s equity with its debt. It proposes tracking implied volatility on out-of-the-money equity puts alongside either the bond Z-spread or the company’s credit default swap spread. If the relationship between these measures moves away from its historical pattern, a trader can investigate the change and consider whether the relationship may revert.

This is a monitoring framework, not a complete trading strategy. The response gives no estimation method, threshold, holding period, hedge ratio, transaction-cost analysis, or performance evidence. It also notes that far out-of-the-money puts may trade over the counter rather than on exchanges, which can complicate data access and valuation. A divergence may reflect a genuine change in credit or equity risk, so historical dislocation alone does not establish mispricing.

Key ideas

• Capital structure relative-value analysis can compare equity option volatility with corporate credit spreads.
• The suggested equity measure is implied volatility from out-of-the-money puts.
• A departure from the historical relationship may prompt investigation and a possible mean-reversion view.
• Far out-of-the-money puts may trade over the counter, and a divergence alone does not prove mispricing.

Tags

# What are the most commonly used models in capital structure arbitrage?


# What are the most commonly used models in capital structure arbitrage?












That is, when trading stocks against bonds of the same companies.

## Answer by Dimitri Vulis (score 1)

https://quant.stackexchange.com/a/58511

For corporations, it is pretty common and also easy to look at the history of

- the implied volatility of the out of the money puts on the common equity (note that far out of the money puts are OTC not exchange-traded)

- the Z-spread of the bonds, or the CDS spread.

When you see their relationship differing from what it's been historically, you can try to understand why it happened, and possibly take a view that it will revert to historical.

This paper (Capital Structure Arbitrage under a Risk-Neutral Calibration by Peter J. Zeitsch, 2017) seems to have a good literature overview.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.