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Who's in, who's out? That's the question faced twice a year by investors and dealers in the credit-derivatives arena, when the existing indexes are replaced with new versions.

It's known as the "roll" and refreshes the names in the indexes, establishing a more accurate representation of the markets they represent. Downgrades to some companies contained in the high-grade index, for example, causes distortions as their credit costs go up, meaning that index is no longer a reliable gauge for credit market participants.

The indexes are the most liquid products in the derivatives world. They are a handy way for investors to take a position on the general direction of the corporate world or protect their debt holdings against default. The existing indexes won't stop trading, however, meaning the credit protection continues to exist.

The next roll in the investment grade derivatives index, the Markit CDX North America Investment Grade index, takes place on Sept. 21, and credit strategists have begun the game of analyzing which issuers will be replaced. Replacements are decided by the dealer banks, which include the biggest names on Wall Street. Liquidity and ratings changes are the key determinants.

For the high-grade index, which groups the credit default swaps of 125 North American companies, the question centers on the status of the beleaguered retailers, and, not surprisingly, embattled small business lender CIT.

Bank of America Merrill Lynch thinks CIT Group Inc. (CIT), which is struggling to restructure outside of bankruptcy, will not be part of the new high-grade index, the IG13. Also on the drop list: retailers JC Penney (JCP) and Macy's (M), as well as furniture group Masco Corp. (MAS). Textron Financial is another candidate.

The concentration on retailers is not a surprise but a reminder that the U.S. consumer isn't readily contributing to an economic recovery.

The analysts recommend replacing the retailers with CDS from cyclical sectors that aren't adequately represented.

"The addition of Kinder Morgan Energy (KMP) would add a benchmark name to the pipelines sector which has only one member in the index (Sempra Energy)." It also recommends adding Reynolds American (RAI), which would "add to Altria in the tobacco sector."

Other suggestions include Genworth Financial (GNW), Commercial Metals (CMC) and auto supplier Johnson Controls (JCI).

Eric Beinstein, head of Investment Grade Strategy and CDS Research at JPMorgan in New York, says dealers are more likely to focus on liquidity versus sectors when considering new credits to include in IG Series 13. He adds that the new IG13 series will likely trade at a lower risk premium, or spread, than IG12 simply because the new credits are replacing ones with higher credit protection costs. "It happens with every roll. The new index will trade at a premium because the replacement names are higher rated credits."

According to rules posted on index administrator Markit's Web site, 10 business days prior to the "roll date" of a new IG Index, each voting member is requested to submit a list of entities currently included in the index that they think should be ousted for the next six-month period. Members are then required to back up their submissions in writing. Majority rules, and the companies with the most votes are replaced with a new set, also chosen by voters.

At last check, the current IG index was quoted at 118.5 basis points. That means it costs $118,500 a year to protect a basket of bonds sold by the companies in the index for five years.

-By Kellie Geressy-Nilsen, Dow Jones Newswires; 212-416-2225; kellie.geressy@dowjones.com