All of these credit derivatives are positive to the long when spreads widen, correct?
Examples:
Credit Spread Call Option - payoff would be: [0, (spread @ maturity - Strike spread)] * Notional * Risk factor - inital cost. (Obviously a credit spread put would be opposite of this - meaning payoff is positive to the long if spreads NARROW, but for drawing similarities let’s ignore that for now.)
Binary Credit Put Option - payoff: (Strike - Mkt Value of bond) - initial cost
Now, the binary credit option technically doesn’t deal with spreads, only Market value due to negative credit events. However, my thought on this is that if a negative credit event happens the spread on the issue will likely increase (e.g. widen) which will cause the mkt value to decrease and create a positive option value for the long put.
Are there any credit derivative calcs that I am forgetting here? I didn’t include the CDS information since I don’t believe there are any formulas for them, they are only conceptual in the books, correct? Thoughts?
Now, the binary credit option technically doesn’t deal with spreads, only Market value due to negative credit events. However, my thought on this is that if a negative credit event happens the spread on the issue will likely increase (e.g. widen) which will cause the mkt value to decrease and create a positive option value for the long put.
I don’t think you should MIX UP the event on the option with the effect of the event.
E.g. - Credit event occurs. Because of that we know that the spread will widen. But that does not mean that some other derivative instrument that deals with that event would apply in this case.
choice is also based “underlying events”…whether it triggers payment when the “underlying spread or price or downgrade etc” happens…
there was one question relating to this. There we were given all this choices & we had to identify which one will be beneficial according to expectations…unable to find it now…
Rahuls- are you refering to the blue box example 14 in the book? volume 4 pg 126-127? I have that one highlighted - it’s a good example to test your knowledge!
That sounds right to me. However if you are sure of spreads widening it would be cheaper to use the credit fwd. Otherwise if you are unsure whether spreads will widen or narrow, the credit spread call option is best.