Credit Spread

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A credit spread can simply be defined as the difference in the values of two security options. With credit spread, the value of the security purchased is less than the value of the security option being sold by an investor. This results to a credit in the investor’s account because more funds are received fro the sale then with the purchase.

Credit spread options is one strategy used by investors to increase their income while minimizing losses. When buying and selling two options with different levels of security, one option is likely to be stagnant (Bearish) where less growth of value is expected in months while the other option is aggressive (Bullish) and increases in value (this is also called a vertical spread). If the trader is using bull spread that uses puts with a bear spread call, this will then earn the investor good amount of profit.

There are some measures to take in a credit spread. The measures to take include the z-spread and option-adjusted spread.

The Z-spread is also called the zero volatility spread or static spread. It is a constant spread that makes the price of a security option equals the sum of the future cash flows. Each cash flow is discounted using zero rates that are adjusted in order to generate the current price to match the market price.

On the other hand, the Option-adjusted spread was develop as a measure of credit spread to evaluate price difference between similar products that has different embedded options. It is the required flat spread over credit spread from treasury to gain discount on payments of security. This is done so that it will match its market price.

Credit spread can make the investor gain money when the volatility goes down. If the price of the underlying will not change, the investor will still earn money. Credit spreads are beneficial to investors buying and selling options over time.