Guide to Credit Default Swaptions

Guide to Credit Default Swaptions - Guide to Credit Default...

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August 25, 2004 Guide to Credit Default Swaptions Using Credit Options to Express Views and Manage Risk We define payer options and receiver options for credit default swaps and explain how to use them to express bullish and bearish views Bullish Bearish Glen Taksler +1 2129332559 glen [email protected] com Derivatives Strategy Buy Receiver Buy Payer Long Call on Credit Long Put on Credit Less Risk Maximum gain is Maximum gain is ( Strike - future spread) x DV01 ( Future spread - strike) x DV01 - premium - premium Maximum Loss is premium Maximum Loss is premium Sell Payer Sell Receiver Short Put on Credit Short Call on Credit More Risk Maximum gain is premium Maximum gain is premium Maximum Loss is Maximum Loss is ( Future spread - strike) x DV01 ( Strike - future spread) x DV01 - premium - premium For simpliCIty payoffs Ignore convexity and assume no credit event See inSide for further details Source: Bane of America Securities LLC estimates Credit default swaptions may express directional views or may hedge risk, and can reduce the cost of carry in shorting a credit The Credit OAS (COAS) model allows investors to estimate the likelihood that they will make money using an option strategy We provide examples of potential trades that use credit swaptions in today's market environment: In Nordstrom', spreads have widened about 10 bps since late Mayan poor earnings and mixed economic data Buy CDS and sell a payer option to short at close to zero carry In Bombardier', spreads have wiqened about 350 bps since late April amid airline industry woes and poor railway revenues Buy an out-of-the-money receiver option to lock in gains on the credit In General Mills', there has been progress in a three-year debt reduction program, but risks remain from a pending SEC investigation and the continuing popularity of anti-carbohydrate diets Spreads tightened 15 bps from March 2004 to June 2004, but have since widened about 5 bps Sell CDS and an out-of-the-money receiver option for a yield pickup over straight CDS, and to hedge against spread widening In Sun Microsystems', spreads have been widening, but the Credit OAS (COAS) model suggests a 54% probability that an investor will make money from selling an at-the-money straddie ,Bane of America Securities LlC was manager or co-manager of a public offering and/or has performed investment banking or other services for this company in the previous 12 months, Please see the important disclosures and analyst certification on page 15 ofthis report" Investors should assume that Bane of America Securities is seeking or will seek investment banking or other business from companies discussed in this report"
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Bane of America Securities Table of Contents Introduction to Credit Default Swaptions "".
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