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- belief that subsidiary has less credit risk than parent: sell CDS on
sub and buy CDS on parent- sell CDS on sub debt and buy CDS on sr.
debt- in a leverage buyout anticipation, investor could buy CDS and and
an equity call option
is higher in the middle of the swap, expect for a current swap, where the notional amounts are swapped at the end
Investor has different opinions than the market about the long-term
versus the short-term prospects for a bond issuer- in a flattener, the
investor believes the issuer has some short-term instability, but that
it's long-term prospects are sound; buy short-term CDS and sell
long-term CDS- investor can match notional principals (taking a position
on duration) or match durations (taking position on default risk)
- CDS premium is compared against the asset swap spread of the
underlying bond (the bond's yield above a benchmark swap rate, which
should reflect the credit risk of the bond)- If the latter is higher
than the CDS premium, the basis is negative, and there is an arbitrage
opportunity, so buy bond and buy CDS- Drawback: investor must finance
the trade; trade disappears quickly typically
- First to Default swap: 5 CDSs, but the investor only provides
protection for the first default (the more CDSs, the higher the premium
paid, or higher spreads on individual CDSs)- high default correlations =
lower premiums
Relationship between changes in risk-free rate and the option
priceCall: positive relationshipPut: negativeNot a very important
sensitivity measure
- long an index and short specific issues in the index- short an index
to hedge or exploit an expected increase in market-wide credit risk-
short credit index and long an equity index
Deep out of the money options have small delta'sAs stock price rises,
call delta goes up, put delta goes downPrices held equal,
out-of-the-money stocks move closer to 0 as time marches and move close
to 1 when in-the-money
It is the right to enter into a specific swap at some date in the
future as the fixed-rate payer at a rate specified in the
swaptionuses:1. lock in fixed rate2. interest rate speculation3. swap
termination (i.e. terminate a 5 year swap with a 2x5 year swaption at
the same fixed rate as the 5 yr swap)value = PV of the difference
between the different payments
The rate of change in delta as the underlying stock price changesA
gamma of 0.04 implies that a $1 increase in the price of the underlying
stock will cause a call option's delta to increase by 0.04, making the
call option more sensitive to changes in the stock priceGamma is largest
when an option is at-the-money and close to expiration
Relationship between volatility of returns on the underlying asset and
option pricePositive relationshipVega gets larger as the option gets
close to being at-the-money
- in a receiver option, the buyer has the right to cell a CDS- in a payer option, the buyer has the right to buy a CDS
Relationship between asset price and option priceCall: positive relationshipPut: negative
Relationship between the passage of time and the option priceAs time
passes and a call approaches maturity, its value declinesTrue for most
puts as well (except deep-in-the-money puts close to maturity)Theta is
less than zero(relationship between option value and time to maturity is
positive;relationship between option value and the passage of time is
negative)
