Saba, BlueCrest

The potential gains lured BlueMountain, Saba and other hedge funds including BlueCrest and Hutchin Hill Capital LP to buy more protection as Iksil continued offering to sell to brokers -- even as it initially led to losses because the JPMorgan trader's bets moved the index lower.

BlueCrest founder Michael Platt said in a May 21 interview with Bloomberg News that the $32 billion hedge fund traded in a "small way" to profit from the distortions.

After JPMorgan announced the $2 billion loss, the cost of the IG9 index surged in anticipation the bank would unwind its bets. The swaps, which had fallen to as low as 102 basis points in March, jumped to 175 on June 5, or $175,000 a year to protect $10 million of debt, according to data provider CMA.

"It could easily get worse," Dimon said of the loss on a May 10 conference call with investors and analysts, when buying protection on the index cost less than 127 basis points, or $127,000 annually for every $10 million insured. A basis point is one-hundredth of a percent.

'Treacherous Landscape'

Exiting the index bets quickly was difficult because they were large relative to the amount that trades on any given day, DTCC data show. Unlike the current version of the index known as Series 18, on which an average $27.6 billion trades each day, $5.5 billion of IG9 exchanged hands each day in the 12 weeks ended June 22.

"When you put on a large trade, it's hard for people not to notice what you're doing," Scott MacDonald, head of research at MC Asset Management Holdings LLC in Stamford, Connecticut, said in a telephone interview last month. "It's a treacherous landscape to be unwinding the trade in."

That's where BlueMountain came in. Because the hedge fund executes so many trades in credit swaps to support its arbitrage strategies, and it falls outside the typical web of market- makers, it was in a better position than JPMorgan to take the bank out of a large chunk of its losing bets without tipping off other investors, said two market participants familiar with credit-swaps trading.

IG9 Protection

"Feldstein is a former JPMorgan exec and likely has a good relationship with senior management," said Miller of GMP Securities. "Since transacting these trades with as little market knowledge as possible is the key to not creating big price fluctuations, who better to go to than a trusted prior colleague?"