Cookbook of CBOE Credit Event Binary Options (CEBO) - CBOE.com

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1. Introduction This guide seeks to provide the ingredients and recipes needed to trade Credit Event Binary Options (CEBO) on a daily basis. It includes a detailed description of the products, pricing indicators, “nuts and bolts” facts useful for trading, trading applications, and background information on the credit market. For more detailed information, please refer to Chapter XXIX of the CBOE Rules. Before proceeding, what are CEBOs? Briefly, they are binary options that provide a hedge against Credit Events such as a bankruptcy or a failure to pay debt obligations. In dollar terms, a CEBO pays a specified amount if a Credit Event is confirmed, and nothing otherwise. In a space of fifteen years or so, the notional exposure of the credit derivatives market has reached almost $34 trillion. This vibrant market has supplanted the traditional corporate bond market as the place to trade credit. The most active contracts are credit default swaps (CDS) and CDS indexes. CEBOs are CBOE’s translation of CDS and CDS indexes to an exchange environment that offer familiar advantages to investors: • A streamlined market place with easy access through securities accounts, transparent pricing, and anonymous trading on the CBOE Hybrid Trading System. • The operational efficiency brought by standardization of contract terms, minimal documentation, immediate and unambiguous resolution of Credit Events, and automated settlement. • Negligible counter-party risk. • Clearing by the "AAA" Rated Options Clearing Corporation (OCC). There is another unique and significant advantage to trading credit options on CBOE. CBOE is also home to stocks, stock and index options, and volatility derivatives, including VIX options. These financial instruments all correlate well to credit, and their trading proximity and common clearing should simplify and reduce the costs of implementing hedging and arbitrage strategies based on these correlations. 2. Description of CEBO Contracts CEBOs are binary options that pay a fixed dollar amount when CBOE confirms a Credit Event in the debt securities issued or guaranteed by some entity 4
(“Reference Entity”). A Credit Event typically means that the issuer or guarantor has ceased to service its debt obligations and/or has filed for bankruptcy. Hence a CEBO can protect against the losses incurred by investors following a default. CBOE currently lists CEBOs referenced to single Reference Entities and launched Basket CEBOs, referenced to baskets of Reference Entities, on August 28, 2007. a. Contract Design Single-Name CEBOs A single-name CEBO is referenced to the debt securities ("Reference Obligations" and “Other Relevant Obligations") issued or guaranteed by a Reference Entity. Its payoff is binary. The option is automatically exercised and pays $100,000 if CBOE confirms that the Reference Entity had a Credit Event between the listing date and the scheduled last day of trading of the option. It pays $0 if no Credit Event is confirmed to have happened during this period. Multiple-Payout Basket CEBOs A Multiple-Payout Basket CEBO is referenced to the debt securities of multiple Reference Entities. Examples are baskets referenced to the debt securities of corporations in the same economic sector, or broad-based baskets referenced to the debt securities of corporations of the same credit quality. On the listing date, CBOE specifies the notional value of the basket, the components of the basket, their basket weights and their estimated recovery rates. For example, a basket could have a notional value of $100,000, 10 equally weighted components, each with a specified recovery rate of 40%. A Multiple-Payout Basket CEBO automatically pays a specified dollar amount each time that CBOE confirms a Credit Event in a component of the basket. The basket component is then removed from the basket and is not replaced. The Credit Event payout is equal to the notional value of the basket times the weight of the component that has the Credit event times one minus its recovery rate. Using the same parameters as in the example above, the option would pay $6,000 (=$100,000 * .10 *(1-.4)) after each confirmed Credit Event. The sum of payout(s) would range from $0 to $60,000 depending on how many Credit Events are confirmed by CBOE over the life of the Multiple-Payout CEBO. First-to-Default Basket CEBO A First-to-Default Basket CEBO, also called “Single-Payout” CEBO basket, is similar to a Multiple-Payout Basket CEBO. The only difference is that the option 5
Page 1 and 2: Cookbook of CBOE Credit Event Binar
Page 3: 1. Introduction Table of Contents 2
Page 7 and 8: Succession and Redemption Events. I
Page 9 and 10: e. Summary Table of Different CEBOs
Page 11 and 12: . Theoretical Pricing The theoretic
Page 13 and 14: Market Maker Haircuts Haircuts for
Page 15 and 16: • Hedge or take a position on the
Page 17: 7. Contact Information John Angelos

Cookbook of CBOE Credit Event Binary Options (CEBO) - CBOE.com

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