---
description: "CDO carry strategy that sells a senior or mezzanine tranche and delta-hedges by buying the CDS index, earning the index spread premium over the tranche cost."
tags: [structured-assets, cdo, carry, senior-tranche, mezzanine, delta-hedge, cds-index]
---

# Carry — Senior/Mezzanine Tranche with Index Hedging

**Section**: 11.3 | **Asset Class**: Structured Assets | **Type**: Carry / Delta-Hedged

## Overview
This is the mirror image of the equity tranche carry trade (Section 11.2). Instead of buying a low-quality tranche and hedging with a short index position, the trader sells a high-quality (senior or mezzanine) tranche and delta-hedges by buying the CDS index. The premiums received from the index exceed the premiums paid on the short senior/mezzanine tranche, generating positive net carry.

## Construction / Mechanics
**Position:**
- Short the senior/mezzanine tranche (protection buyer): pay spread S_senior
- Long the CDS index (protection seller): receive spread S_index

**Delta (hedge ratio):** Same formula as Eq. (487):

```
Δ_ix = D / D_ix                                              (487)
```

where D is the risky duration of the senior/mezzanine tranche and D_ix is the risky duration of the CDS index.

**Economics:**
- Premium received from the long index position > premium paid on the short senior/mezzanine tranche
- This trade is the opposite of the equity tranche strategy: the index premiums fund the tranche premium cost

## Return Profile
Earns positive carry as long as defaults do not trigger payouts on the index position that exceed the spread income. The hedged position is approximately spread-neutral to small parallel credit spread moves. The long index position compensates for portfolio-level default losses; the short senior tranche position profits from non-extreme loss scenarios.

## Key Parameters / Signals
| Parameter | Description |
|-----------|-------------|
| Δ_ix = D / D_ix | Hedge ratio: senior/mezzanine tranche risky duration / index risky duration |
| S_index | Spread received on long CDS index position |
| S_senior | Spread paid on short senior/mezzanine tranche |
| Net carry | Δ_ix × S_index - S_senior (approximately) |

## Variations
- Adjust the quality of the tranche sold (from mezzanine to super-senior) to tune the risk/carry trade-off.
- Use multiple tranches at different quality levels to diversify the credit curve exposure.

## Notes
- This strategy is "opposite" to the equity tranche carry trade: the long CDS index position exposes the trader to portfolio-level defaults, while the short senior tranche benefits from low-to-moderate loss scenarios.
- The net carry is typically lower than the equity tranche trade because senior tranche spreads are lower.
- Correlation risk applies here as well: if correlation decreases (idiosyncratic defaults increase), the index position is hit harder than a diversified senior tranche.
- The CDS index is a liquid instrument; basis risk between the index and individual tranche spreads is a key residual risk.