An option on a credit default swap (CDS) or a collateralized debt obligation (CDO). A default swaption is an OTC instrument which grants the holder the right, without the obligation, to enter into a single name CDS (either as a protection buyer or a protection seller) on a specified date (inception date) and at a specified spread as set out in the contract. Default swaptions may have a knock out feature, whereby if the reference name underlying the CDS defaults prior to the swaption’s inception date, the swaption is knocked out and the contract ceases to exist.
An option to buy protection is known as a payer swaption, while an option to sell protection is referred to as a receiver swaption.
It is also known as a CDS option or a credit default swaption.
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