(Bloomberg) -- A sudden decision by Weatherford International Plc to pursue bankruptcy wrong-footed Goldman Sachs Group Inc. traders who seemed to have a sure-fire derivatives bet.
Goldman Sachs’s credit traders had positioned themselves through a default-swaps wager that would have benefited if Weatherford managed to avoid near-term death, even if its longer-term prospects remained bleak, according to people with knowledge of the matter.
The trade is notable for its sudden collapse and is likely to rank among the duds this quarter for the leveraged-finance trading team led by Tom Malafronte. But while the losses were notable for the desk, it’s expected to have limited impact on the trading division’s overall performance, the people said, without disclosing exact figures.
In this case, the desk was selling short-dated credit swaps contracts, expecting Weatherford to avoid default over the next year while purchasing longer-term derivatives that would still benefit from an eventual collapse for the oilfield services provider.
Goldman Sachs stands out from peers by often making chunky credit bets in excess of what their banking rivals have shown a stomach for, according to several market participants. Such wagers have internally been justified as necessary to build inventories in anticipation of client needs.
A spokesman for the bank declined to comment.
Weatherford surprised markets this month by striking a bankruptcy deal with lenders that would rank among the energy sector’s biggest over the past few years. Many financially-troubled companies in the last decade have repeatedly cut deals with their creditors to avoid defaults and give them time to bounce back. That’s one reason Goldman Sachs would have felt confident with its trading position.
Curve arbitrage is a popular strategy for traders seeking to wager on distressed companies’ short and long-term prospects. In a so-called steepener, a trader typically has a bearish view on a company but doesn’t expect it to go belly-up immediately. It’s effectively a bet that collapsing shorter-term CDS prices set against higher long-dated contracts will result in a steeper curve.
If a company cuts a deal with creditors such as extending maturities, the trade can be profitable. In the case of Weatherford, the trade backfired when creditors signed on to a bankruptcy plan instead of a debt extension, causing six-month and one-year CDS to soar.
--With assistance from David Wethe.
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