UNDERLYING IS A CREDIT SPREAD ON A REFERENCE OBLIGATION

When the underlying for a credit spread option is the credit spread for a reference obligation over a referenced benchmark, then the payoff of a call and a put option are as follows:

Credit spread call option:

payoff =

(credit spread at exercise — strike credit spread) x notional amount x risk factor

Credit spread put option:

payoff =

(strike credit spread — credit spread at exercise) x notional amount x risk factor

The strike credit spread (in decimal form) is fixed at the outset of the option. The credit spread at exercise (in decimal form) is the credit spread over a referenced benchmark at the exercise date.

The risk factor is equal to

risk factor = 10,000 x percentage price change for 1-basis-point change in rates for the reference obligation Read the rest of this entry »