Trading in credit “swaptions” – options to buy or sell credit default swaps – has increased over the past year since hedge funds and other investors use them for short-term speculation.

According to a report by Fitch Ratings, the investment rating agency, they are given preference due to the fact that they provide leverage and a short investment time-frame. Many dealers said the instruments enabled them to express more complex views than they were able with simple CDS positions. Their main disadvantage was that they lacked liquidity.

The CDSs, which allow investors hedge or take on risk on bonds and loans, can be found either on individual companies – single names – or on traded indices. Most single-name activity is prevailed by a number of the most active names in the bond and CDS markets, comprising Ford, General Motors and Eastman Kodak.

Hedge funds used to be the most significant users, accounting for 57 per cent of the total. Liquidity should be improve before the more traditional money managers get involved, said Fitch.

But investors were recommended in order to use credit swaptions with care. Most single-name options are of the “knockout” variety and become worthless if the underlying entity defaults.