If an investor buys a 12-month credit spread put option on XYZ Ltd.’s bond with a...

If an investor buys a 12-month credit spread put option on XYZ Ltd.’s bond with a strike spread of 150bps for a premium of 55 bps, what is the appropriate course of action if XYZ Ltd’s spread tightens to 50bps? Widens to 250bps? What is the breakeven level of trade? Illustrate your answers with the bond value movements.

Solutions

Expert Solution

Investor has bought a put option so he will be profitable only if the spread tightens

If tightens to 50 bps

Profit will be 150-55-50 = 45bps

If the spread widens to 250 then the option will be out of money and there will be no payoff

There will be loss of premium that is 55 bps

Break even point is the level at which there will be no profit or loss

So payoff from the option shall be 55

Break even = 150-55 = 95bps

jeff jeffy answered 1 year ago

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