Credit Spread Option

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.

BREAKING DOWN '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. Credit Spread

    1. The spread between Treasury securities and non-Treasury securities ...
  2. Buy A Spread

    Option strategy that will be profitable if the underlying security ...
  3. Long Leg

    The part of an option spread strategy that involves buying an ...
  4. Short Leg

    Any contract in an option spread in which an individual holds ...
  5. Spread Option

    A type of option that derives its value from the difference between ...
  6. Trade Credit

    An agreement where a customer can purchase goods on account (without ...
Related Articles
  1. Professionals

    Spreading

    Spreading
  2. Options & Futures

    Option Spreads: Tips And Things To Consider

    By John Summa, CTA, PhD, Founder of OptionsNerd.comNow that you have obtained a solid foundation for underlying option spreads, here are some tips on how to use them. In this section, we'll ...
  3. Investing Basics

    Explaining Credit Spread

    A credit spread has two different meanings, one referring to bonds, the other to options.
  4. 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.
  5. Options & Futures

    Option Spreads: Vertical Spreads

    By John Summa, CTA, PhD, Founder of OptionsNerd.comLimiting Risk with Long and Short Options Legs We have seen that a spread is simply the combination of two legs, one short and one long (but ...
  6. Options & Futures

    Option Spreads: Credit Spreads Structure

    By John Summa, CTA, PhD, Founder of OptionsNerd.comNow that you have a basic idea of what an option spread looks and feels like (of course limited to our simple vertical bull call spread), let's ...
  7. Options & Futures

    Which Vertical Option Spread Should You Use?

    Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading.
  8. Bonds & Fixed Income

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  9. Professionals

    Summary And Review

    Summary And Review
  10. Professionals

    Options and their Benefits

    CFA Level 1 - Options and their Benefits. Learn how some options can benefit the holder of a bond, while others benefit the issuer. Relates the degree of liquidity to yield spreads.
RELATED FAQS
  1. What's the difference between a credit spread and a debt spread?

    Learn about debit and credit option spread strategies, how these strategies are used, and the differences between debit spreads ... Read Answer >>
  2. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
  3. How do I set a strike price in an options spread?

    Find out more about option spread strategies, and how to set the strike prices for bull call spreads and bull put spreads ... Read Answer >>
  4. What is spread hedging?

    Learn about one of the most common risk-management strategies options traders use, called spread hedging, to limit exposure ... Read Answer >>
  5. What is the average debt/equity ratio for the Internet sector?

    Learn about how debit option spreads work, including their maximum profit and loss, and understand how time decay impacts ... Read Answer >>
  6. What are the most popular and useful measures of credit spread?

    Learn about the different types of credit spread measures that measure risk, including the zero-volatility spread and the ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center