A credit spread option is an option whose value/payoff depends on the change in credit spread for a reference obligation. It is critical in discussing credit spread options to define what the underlying is. The underlining can be either

  1. a reference obligation, which is a credit-risky bond with a fixed credit spread, or
  2. the level of the credit spread for a reference obligation

UNDERLYING IS A REFERENCE OBLIGATION WITH A FIXED CREDIT SPREAD

When the underlying is a reference obligation with a fixed credit spread, then a credit spread option is defined as follows:

Credit spread put option: An option that grants the option buyer the right, but not the obligation, to sell a reference obligation at a price that is determined by a strike credit spread over a referenced benchmark. Read the rest of this entry »