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Credit Indices (CDX / iTraxx)

One-line definition

A credit default swap index is a standardized basket of single-name CDS on a fixed list of reference entities — CDX for North American and Emerging Market names, iTraxx for European, Asian, and other markets — traded as one liquid instrument instead of assembling dozens of individual CDS trades.

Formula

Intrinsic value (this repo's simplified version):

index_intrinsic_spread = weighted_average(constituent_spreads)

(real intrinsic-value calculations PV01-weight the constituents; this repo's version takes weights as given, equal-weighted by default — see Limitations)

index_basis = index_spread - intrinsic_spread

Why PMs care

A credit index is the fastest way to express (or hedge) a macro credit view without picking individual names — buy protection on CDX.HY to hedge a high-yield book, or sell protection on CDX.IG to add cheap long-credit-beta exposure. The index basis is the standard relative- value signal between the index and its constituents: when it strays from zero, an arbitrage trade (sell protection on whichever side pays more spread for the same risk, buy protection on the other) tends to pull it back — that flow is a real part of why credit indices stay tightly linked to their constituents even though they trade separately.

Worked example

Five constituent CDS spreads (in bp): 80, 90, 100, 70, 110. Equal- weighted intrinsic value: index_intrinsic_spread([80,90,100,70,110]) = 90. If the index itself trades at 95bp, index_basis(95, 90) = +5 — a 5bp gap between the traded index and what its constituents would imply on their own.

Common mistakes

  • treating CDX and iTraxx as interchangeable — they cover different regions/issuers and roll on different (though coordinated) semi-annual schedules
  • forgetting the index basis has a sign, and that "which side is cheap" depends on that sign carefully, not just its magnitude — get this backwards and a relative-value trade is structured in the wrong direction entirely
  • using the theoretical (par) spread interchangeably with the traded fixed-coupon convention most indices actually quote under — the two aren't the same number and index pricing reconciles them with an upfront payment

Limitations

index_intrinsic_spread here uses simple (equal, unless given) weights. Real intrinsic-value calculations PV01-weight each constituent — a name with a longer effective maturity or higher spread contributes more to the index's true sensitivity than a simple average captures. Treat this repo's version as directionally correct for a quick estimate, not a trading-desk-grade intrinsic-value calculation.

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