Credit Options

Introduction to CBOE Credit Option Complex

The credit derivatives universe is a massive market space with enormous potential. It is one of the most important segments of the OTC market and recent reports have calculated the outstanding notional value to be $30 trillion. The industry's effort to decrease systemic risk by netting outstanding contracts has reduced these levels from their pre-credit crisis highs of $60 trillion to approximately $30 trillion today, which is still very significant. Regulators and market participants have devoted much attention to the "back end" and the central clearing process as a means to moderate systemic risk. Since this effort began, approximately $10 trillion CDSs have been centrally cleared - an impressive figure, but just one initial step towards truly significant reduction of systemic risk. CBOE believes that we can provide additional benefits to the customer and the industry by addressing the "front end" trading process through creating a tradeable listed credit derivative product. Some of the inherent advantages that our listed market can provide are: transparency, anonymity, standardized contract terms, central clearing and settlement, and the option of floor-based or electronic trading in a securities exchange regulated environment. As a result, Chicago Board Options Exchange (CBOE) plans to list credit derivative products called Credit Event Binary Options (CEBOs) for trading later this year (See Below).

CREDIT EVENT BINARY OPTIONS (CEBOs)

• CEBOs translate credit default swaps (CDS) into a transparent, exchange traded marketplace. Originally launched in mid-2007, CBOE is looking to re-launch with modifications.
• CEBOs are binary options that pay fixed amounts upon a streamlined credit event definition which includes bankruptcy only.
• CEBOs are similar to fixed recovery CDS contracts but are exchange traded and can be purchased with an upfront premium that can be margined.

Exchange Traded Advantages:

1. Transparency

• Terms are simplified and payout determinations are objective and predetermined.
• Trading environment allows for price discovery and certainty of execution.

2. Counterparty Risk Protection

• Virtual elimination of counterparty risk; all trades are cleared by the AAA-rated Options Clearing Corporation (OCC).
• Regulated exchanges delivered as promised during the recent crisis: no failures, no closures, no taxpayer rescues.

3. Operational Efficiencies

• Trades are executed through securities accounts allowing synergies with equity-related options products.
• NO ISDA Agreements required.
• Hybrid trading platform (floor-based or electronic) and CFLEX eligible.
• CBOE plans to list CEBOs with a broad universe of corporate names and potential maturities.

CBOE views credit derivatives as a natural extension of our equity options business. Equity option premiums reflect changes to the credit ratings of the underlying security. For example, put values should increase on concerns that the underlying entity will declare bankruptcy. In practice, there currently exist numerous institutions that trade equity options versus credit derivative products. Our new product line will enable these traders and many others to access equity options and credit options through the same channels.

For additional information please contact:
John Angelos at (312) 786-7063 or angelos@cboe.com
Matt McFarland at (312) 786-7978 or McFarland@cboe.com