Credit Spread Option

AAA

DEFINITION of 'Credit Spread Option'

A financial derivative contract that transfers credit risk from one party to another. An initial premium is paid by the buyer in exchange for potential cash flows if a given credit spread changes from its current level.

The buyer of a credit spread option will receive cash flows if the credit spread between two specific benchmarks widens or narrows. Credit spread options come in the form of both calls and puts, allowing both long and short credit positions.

INVESTOPEDIA EXPLAINS 'Credit Spread Option'

Credit spread options can be issued by holders of a specific company's debt to hedge against the risk of a negative credit event. The buyer of the credit spread option (call) assumes all or a portion of the risk of default, and will pay the option seller if the spread between the company's debt and a benchmark level (such as LIBOR) grows.

Options and other derivatives based on credit spreads are vital tools for managing the risks associated with lower-rated bonds and debt.


RELATED TERMS
  1. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  2. Cat Spread

    A cat spread is a type of derivative traded on the Chicago Board ...
  3. Spread

    1. The difference between the bid and the ask price of a security ...
  4. Junk Bond

    A colloquial term for a high-yield or non-investment grade bond. ...
  5. Hedge Ratio

    1. A ratio comparing the value of a position protected via a ...
  6. Perfect Hedge

    A position undertaken by an investor that would eliminate the ...
RELATED FAQS
  1. Where can I find year-to-date (YTD) returns for benchmarks?

    Benchmarks are securities or groups of securities against which investment performance is analyzed. Examples of popular equity ... Read Full Answer >>
  2. What is the effective interest method of amortization?

    The effective interest method is an accounting practice used for discounting a bond. This method is used for bonds sold at ... Read Full Answer >>
  3. Under what circumstances would someone enter into a repurchase agreement?

    In finance, a repurchase agreement represents a contract between two parties, where one party sells a security to the other ... Read Full Answer >>
  4. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  5. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
  6. What type of asset allocation should I use if I am already retired?

    Among investors, asset allocation is a topic of discussion that receives a great deal of weight during the asset accumulation ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  2. Options & Futures

    Vertical Bull and Bear Credit Spreads

    This trading strategy is an excellent limited-risk strategy that can be used with equity as well as commodity and futures options.
  3. Options & Futures

    Iron Condors: Wing It To Maximum Profit

    Understanding the right way to execute an iron condor can increase potential returns and limit risk.
  4. Options & Futures

    Understanding Option Pricing

    Take advantage of stock movements by getting to know these derivatives.
  5. Bonds & Fixed Income

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  6. Fundamental Analysis

    Understanding the Profitability Index

    The profitability index (PI) is a modification of the net present value method of assessing an investment’s attractiveness.
  7. Economics

    What is Neoliberalism?

    Neoliberalism is a little-used term to describe an economy where the government has few, if any, controls on economic factors.
  8. Fundamental Analysis

    Explaining the Monte Carlo Simulation

    Monte Carlo simulation is an analysis done by running a number of different variables through a model in order to determine the different outcomes.
  9. Economics

    What's a Maturity Date?

    Maturity date is the final date when any remaining principal and any unpaid interest are due on a debt.
  10. Professionals

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).

You May Also Like

Hot Definitions
  1. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
  2. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  3. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  4. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  5. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  6. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!