Feldstein laid out a plan to restructure the fund, and investors owning 80 percent of the assets agreed to keep their money in place while markets improved, according to a November 2008 letter to investors, a copy of which was obtained at the time by Bloomberg News.

Gap Arbitrage

The credit-alternatives fund, which lost 6 percent in 2008, went on to return 24.4 percent in the first eight months of 2009 as markets recovered from the crisis, according to a letter to investors at the time.

One of the trades BlueMountain has mastered better than almost any other hedge fund, according to market participants, involves arbitraging the gap between credit-swaps indexes and contracts on the companies tied to those benchmarks. When the cost to buy protection on the index drops below the average cost of swaps on the companies, the fund will purchase protection on the benchmark and sell it on its constituents, profiting when the swaps converge.

London Whale

That was the opportunity that funds from BlueMountain to Saba noticed last year as a trader in JPMorgan's chief investment office in London, Bruno Iksil, began making outsized bets on the Markit CDX North America Investment Grade Index Series 9. The index, known as IG9, is tied to 121 companies that were investment-grade when it was created in September 2007, including now junk-rated bond guarantor MBIA Insurance Corp., a unit of MBIA Inc., and retailer J.C. Penney Co.

Dimon, 56, transformed the chief investment office in recent years to make bigger and riskier speculative trades with the bank's money, Bloomberg News first reported April 13, based on information provided by five former employees. Iksil managed a portfolio of credit swaps that, Dimon told the Senate Banking Committee June 13, was intended to profit in a financial crisis and make "a little money" in a benign market.

Iksil's group was instructed to cut positions in December in anticipation of new capital rules, Dimon told the Senate panel. Instead Iksil, who became known as the London Whale for the size of his bets, sought to offset the hedges by selling protection on the IG9 index through December 2017 to dealers such as Bank of America Corp. and Citigroup Inc., which in turn sold that protection to money managers including BlueMountain and Saba, market participants said.

Iksil's Bets

In the 14 weeks ended April 6, outstanding bets on the index using credit swaps surged an unprecedented 65 percent to $148.2 billion, according to the Depository Trust & Clearing Corp., which runs a central registry for the market.

The net amount of credit-derivatives protection the bank sold on investment-grade companies using contracts expiring in more than five years doubled to $101.3 billion in the three months ended March 31, Federal Reserve data shows.

Iksil's bets were so large that he drove the price of the index far below the average of the underlying companies. That made the price of the index equivalent to buying $1 of protection for about 80 cents, market participants said. Hedge funds could arbitrage the gap and build positions against JPMorgan by buying swaps on the index and selling CDS on the constituent companies.