Credit Event Binary Options (CEBO®s)
Introduction to Listed Credit Derivatives
Credit derivatives are one of the most important segments of the institutional Over-the-Counter (OTC) market and recent reports have calculated the outstanding notional value to be $30 trillion as of June, 2010. 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 its current level, 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 Credit Default Swaps (CDS) have been centrally cleared - an impressive figure, but just one initial step towards a 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, standardized contract terms, central clearing and settlement, and the choice of floor-based or electronic trading in a securities exchange regulated environment.
CEBOs are binary options designed as a streamlined approach for investors both large and small who are unable to access the OTC credit space but want to participate in this significant and rapidly growing market or for those who just prefer an alternative to CDS.
- CEBOs translate CDS exposure into a transparent exchange traded marketplace.
- CEBOs are binary options that pay fixed amounts upon a streamlined credit event, which may include 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.
- CEBO premiums reflect a company's discounted Probability-of-Default during the contract's life.
Exchange Traded Advantage
- Trading environment allows for unbiased price discovery.
- Daily and final settlement prices are completely objective and independent.
2. Operational Efficiencies
- NO International Swaps and Derivatives Association (ISDA®) agreements required - trades are executed on an exchange and housed in a standard securities account.
- Terms are standardized, simplified, objective, and predetermined.
- Immediate and unambiguous confirmation of credit events and cash settlement.
- Hybrid trading platform (floor based and electronic), CFLEX® and RFQ eligible.
3. Counterparty Risk Protection
- Virtual elimination of counterparty risk; all trades are cleared by the Options Clearing Corporation (OCC).
- Regulated by the Securities Exchange Commission (SEC)
- Regulated exchanges delivered as promised during the recent crisis: no failures, no closures, no taxpayer rescues.
CEBOs were designed to assist portfolio managers in actively managing their corporate credit exposure (e.g., a company's bankruptcy) and to provide speculators with a convenient method to express their opinion on current and anticipated levels of creditworthiness of companies.
CEBOs are types of insurance policies which are inversely correlated to the creditworthiness of a single company or of an entire market sector. The value of the CEBO will reflect the company's credit outlook changes stemming from a rating agency's formal assessment or informally from market participants' analysis, etc. As a company's corporate bond prices decline due to deteriorating credit the value of a CEBO based on that company will rise to reflect this additional risk.
Source: Bloomberg and CBOE