An option to buy (if a call) or sell (if a put) a prearranged multi-name credit default swap (CDS). It gives the buyer the right, but not the obligation, to receive or sell protection on a set of names (reference entities/ assets/ issuers) for a predetermined premium (upfront default insurance cost). The strike price is written on the market value of the underlying credit default swaps at the option’s expiration date.
This option has the effect of triggering the credit event payment when a credit event occurs to one or more of the reference entities/ assets during the life of the option. In this event, the protection seller will have to make it good for the protection buyer either physically or by net cash. This coincides with the option automatically knocking out. If no credit event has taken place during the option’s term, the option simply expires without the protection seller being required to make any remedial payment.
Examples of multi-name credit default swap option include: index default swaptions, basket default swaptions, portfolio default swaptions, etc.
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