Credit spread call option vs credit spread put option

G

grgkir001

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
Can someone please help - in Vol 1 Exam 2 Q14.5 solution Schweser says:
“A credit spread call option will provide protection if the reference asset’s spread at maturity increases beyond the strike spread. Payoff may be delivery of physical or cash settlement”
Then they say of credit spread puts:
“If the credit spread on an asset exceeds the ref spread the put holder has the right to sell the asset to the put writer at the price determined by the ref spread”
It seems that at the end of the day they both protect against increasing spreads but one gives the right to sell the underlying while the other you can choose cash or the underlying so you’re essentially being compensated for the drop in value of the underlying. it seems like the put is on the actual asset more than the spread of the asset and the call is on the spread…please can someone clarify?? there are so many variations of all these things i’m not sure how to remember what everything is/does!
 
I would also like to know.
So it seems like in both scenario, option holder will be beneficial if ref rate increases beyond the strike price, correct?
 
Credit spread put is a binary option based on whether a bond’s rating falls or not. suppose i own a bond of ABC (its AA rated now). i am concerned about its rating downgrade below BBB (to below-investment grade) so i buy a credit put option that pays when ratings downgrade ocurs and no payoff when no downgrade occurs. and payoff = max (strike price- price at maturity,0)
credit spread call option is option based on spread over a benhmark rate. if spread at maturity is greater than strike spread, (i.e. spread widening denotes an unfavourable event against which we want to be protected), then we have a +ve payoff and payoff = max (S-X,0) * NP * RF
 
Think i can explain it more precisely …. FOR BINARY PUT OPTION
A binary credit put option is based on ratings downgrade (especially from investment grade to below-investment grade). Suppose I own bonds of ABC corp, AA rated at price of $1000 per bond. I am concerned about ratings downgrade and would like to put the bond back to issuer in case such downgrade occurs.
Case 1. Suppose at maturity, ratings on ABC bond fall to BB (my fears come true) and its price reduces to $850. Hence my binary put will come in the money and payoff will be = max (1000 – 850, 0) = 150 per bond. Hence i’ll receive a payoff whenever a ratings downgrade occurs and price falls below strike of 1000.
Case 2. If at maturity, no downgrade occurs and ratings improve further to AAA, price will rise to $ 1100. Then put option will expire out of money and payoff will be 0.
hope this helps.
 
level3aspirant,
I am confused. As far as I know, Credit Spread Put is different from Binary Credit (Put) option. The first one described by you shall be Binary Credit (Put) option.
Correct me if I am wrong !
 
As far as i understand this topic, under credit options we have:
1. Binary credit options based on default of underlying asset (equivalent to credit put option if based on credit rating of underlying asset)
2. credit spread (call) option
 
As far as i understand this topic, under credit options we have:
1. Binary credit options based on default of underlying asset (referred to as credit put option if based on credit rating of underlying asset)
2. credit spread (call) option
 
binary credit puts are based on price
credit spread call options are based on spreads.
since spreads and price are inversely related, i.e. as spreads rise, price falls; therefore price scenarios are evaluated using puts and spread scenarios using calls.
 
I went into the same question as grgkir001 a couple of months ago.
From my memory, Schwezer notes only mention the more common 2 options, binary credit puts and credit spread call. However, there are actually 4 in the CFA text. Nevertheless, the less common 2 options are discussed very briefly in CFA text and easy to be missed. I know it may look counter-intuitive to have binary credit calls and credit spread put.
binary credit puts – provide protection if price goes down due to credit event
binary credit calls – provide protection if price goes up due to credit event
credit spread call – provide protection if credit spreads go up
credit spread put – provide protection if credit spreads go down
There is a couple example or EOC Qs in the text regarding these 4 types. I will take a look tonite and post where it is.
Besides, I also had the some problems with the explanation on Vol 1 Exam 2 Q14.5. I don’t remember it much. Well, I will take a look tonite.
 
thanks for all the responses…happy with the existence of binary options and spread options but still not sure about the diff btwn credit spread puts and credit spread calls as like James says, the explanation in schweser is a little strange - my biggest problem with it is that it seems credit spread puts and credit spread calls both paying off when spreads increase beyond strike spread or price drops below that implied by the strike spread. to me it would make more sense if it were like James says above where put pays off for decreasing spreads (say if you want to buy bond x because you think the spread will decrease) and call for increasing spreads…
appreciae it if you could get back when you’ve checked it out James.
TVM!
 
so now I am confused, does this scenario not make sense for credit spread options:
- when puying a credit spread put your are buying protection against a decrease in prices, so your are concerned with increasing spreads.
- when buying a call you are betting against increase in price, so you are betting spreads widen.
thx.
 
The info is in the CFA book 4 right around page 127.
In looking at the info James had, I don’t see a Binary Credit Call.
Not sure if that exists because the Binary is an event happens or it doesn’t happen.
Someone wouldn’t be selling protection if they think an event will cause it to improve.
Not completely sure though.
For Credit Spread Call- you are betting through the use of an option that Spreads are going to increase. (Spread - strike spread) X Notional X Risk Factor. If you are out of the money then you lose your premium.
Credit Spread Put- you are betting through the use of an option that Spreads are going to narrow.
(Strike spread - spread) X Notional X Risk Factor.
 
that’s great that book confirms that - it’s not what Schweser have put in their explanation for Q14.5 in the practice exam as i mentioned to start with but i’ll just ignore their explanation as it’s clearly dodgy.
binary credit option does exist and is in schweser with credit spread options.
thx
 
in Q14.5
the difference between binary credit put option and credit spread call option is,
1.binary credit put option is based on underlying asset’s price, and triggered by default or downgrade credit rating. a wider spread or a decline in value , not downgrade rating won’t trigger.
2.credit spread call option is based on yield spread, triggered by increased spread beyond strike spread, whatever credit rating is down or level. Because spread is affected not only by credit rating, but also other factors.
In Q14.5, Weaver worries the wider spread, thus Credit spread call option is better than binary credit put option.
choice A. creidt default swap seems like binary credit put option, the only difference I can see is the CDS is custom-designed. any other thoughts?
 
James@Houston Wrote:
——————————————————-
> binary credit calls – provide protection if price goes up due to credit event
>
> credit spread put – provide protection if credit spreads go down
I think price up is good or credit spreads go down are good and no need to protect, is it that these 2 options enable investors to take advantage of price up or credit spreads go down ?
Actually price up = credit spreads go down.
 
James@Houston Wrote:
——————————————————-
> binary credit calls – provide protection if price goes up due to credit event
>
> credit spread put – provide protection if credit spreads go down
I think price up or credit spreads go down are good and no need to protect, is it that these 2 options enable investors to take advantage of price up or credit spreads go down ? i.e., investors can buy the underlying at a strike price which lower than the market price. If so, this is intuitive for binary credit call (to buy) but it seems do not make sense for credit spread put (to sell).
Actually, price up = credit spreads go down.
 
GMofDen Wrote:
——————————————————-
> The info is in the CFA book 4 right around page
> 127.
>
> In looking at the info James had, I don’t see a
> Binary Credit Call.
> Not sure if that exists because the Binary is an
> event happens or it doesn’t happen.
> Someone wouldn’t be selling protection if they
> think an event will cause it to improve.
> Not completely sure though.
I don’t think there is Binary Credit call as well after looking at the V4 Pg127 example 14. Please disregard my previous post. Sorry! Moreover, it says in the glossary that binary credit options provide payoffs contingent on the occurrence of a specified “negative”credit event, so it seems there can only be Binary credit puts.
For credit spread calls and puts, it can be either used as protection or making bets based on the mgr.’s expectation of the movement of credit spread (like many of you folks already discussed above).
I believe Schweser Vol 1 Exam 2 Q14.5 solution is wrong about the credit spread puts. I will make an errata reporting tonite.
 
I don’t quite understand the logic behind credit forward contracts.
So if you are a buyer of a credit forward, you gain if spreads widen? Hows that? If you are locked in with a lower spread (higher price) and spreads widen, aren’t you actually paying a higher price than the contract?
Same thing with credit option call spread contracts. You gain when spreads widen? Don’t you take into account the price changes? Isn’t a total return perspective much better than just a yield perspective?
 
sparty419 Wrote:
> So if you are a buyer of a credit forward, you
> gain if spreads widen? Hows that? If you are
> locked in with a lower spread (higher price) and
> spreads widen, aren’t you actually paying a higher
> price than the contract?
You and your counterparty in a credit spread forward bet on different direction of credit spread in order to either hedge an existing bond position or just speculating.
Let’s say you hold bond A and you predict the issuer’s credit spread will widen within 3 months, which will result in decrease in bond A value. In order to protect yourself, you purchase a 3-mo. credit spread forwards from a counterparty. You will receive a payment from your counterparty 3 months later if the credit spread is > strike spread of your contract. The payment may not exactly match your bond A lose value, depending on how you set up the risk factor in the contract initially. Your gain from the forward somewhat offsets your loss from bond A position.
Note that you will end up pay your counterparty instead if the credit spread turns narrower at contract maturity. At the same time, your loss offsets by your gain from bond A position to certain extent.
>
> Same thing with credit option call spread
> contracts. You gain when spreads widen? Don’t you
> take into account the price changes? Isn’t a total
> return perspective much better than just a yield
> perspective?
My opinion is–
Many factors can cause price changes–interest rates, downgrade, default, mkt supply & demand, credit spread etc. There is a variety of derivatives to hedge different risks.
–Perhaps there is not a cost-effective way to hedge all risks.
–Mgrs. always want to expose to certain risks in order to earn additional return and hedge others based on their forecast. They use specific derivatives to modify their exposures.
 
You must log in or register to reply here.
Back
Top