Credit Spread Options (Put & Call)

A credit spread option is a hedge/bet on the narrowing or widening of a credit spread (credit spread = risky yield - riskless yield). The credit spread put payoff = duration x notional x MAX [Credit Spread - Strike Spread, 0]. The Credit spread call payoff = duration x notional x MAX [Strike Spread - Credit Spread, 0]. So a buyer of a credit spread call profits from a narrowing of the spread. For example, investor holds foreign bond and thinks that foreign economy will improve such that credit spread will narrow. He or she could sell (short) a credit spread put or buy a credit spread call. But note these are not the same: the short put merely hopes to pocket the up-front premium (limited payoff), the long call has unlimited upside.

Category:

Education

Tags:

• Finance
• Derivative

[bullzandbearz]

Nice video on spreads. I trade them monthly and definitely would suggest that people stay out of the weekly game on these. You can just get too close to the market and volatility can jump dramatically.

[missedagain]

@TorynHill nothing in the world is risk-free, ceteris paribus is a necessity

[TorynHill]

lol T-Bills aren't risk free. Bury your briefcase full of treasuries next to my chest full of gold and silver and let's reevaluate in 20 years.

[Rickroll604]

Great video, thanks

[supersimpson2001]

Could someone help me out? My textbook here says that (quote) "A credit spread call option is a call option whose payoff increases as the risk premium or yield spread on a specified benchmark bond of the borrower increases above some exercise spread". Why is my textbook implying that you stand to GAIN if the spread WIDENS for a credit spread CALL option? That's opposite of what you said.

[dubseller]

very informative. THANKS! But could you possibly show an example in a video?

[cjharrol]

Yeah, for credit spreads