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Created by Dr. Jan-Frederik Mai


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Put = CDS + X

Long credit exposure in some company may be hedged either by buying CDS protection that triggers when a credit event with respect to the company is determined, or alternatively by buying put options on the company’s stock price process – at least when it is justified that the stock price drops to zero upon the arrival of a credit event. Under this assumption, it is explained how the cost for put protection may be decomposed into two parts: (1) the cost for CDS protection (pure default protection) and (2) a remaining part that accounts for potential gains due to equity volatility (pure gamma). The proposed measurements are model-free, efficient to compute, and can help to get a feeling for how much default and gamma risk is priced into a specific put option.

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