Pricing an Option Linked to the Writer’s Own CDS Spread

Summary

The document poses a derivative-pricing question: how to set a fair premium for an option whose payoff depends on the writer’s own credit default swap spread. It highlights a central complication: the writer cannot hedge the exposure in the usual way by buying protection against its own default. It also recognizes that “fair” may have different meanings in this setting.

No payoff formula, maturity, valuation framework, market quote, or proposed premium is supplied, and the text does not resolve how to treat the writer’s own default or the lack of a concrete hedge. As a result, it frames a problem involving credit risk, hedging limits, and the meaning of fair value rather than presenting a pricing method. Any valuation would need to define the contract and the relevant pricing assumptions, details that remain unspecified here.

Key ideas

• The proposed option payoff is indexed to the writer’s own CDS spread.
• The writer describes an inability to hedge by selling protection against its own default.
• The question raises ambiguity about what fair premium means when a direct hedge is unavailable.
• No contract terms, valuation model, or premium estimate are provided.

Tags

# Writing option on one's own default


# Writing option on one's own default












Maybe this is a weird question, but suppose that, for some reason, one would like to write an (implicit) option whose payoff is indexed on the writer's CDS spread. I would like to know what would be a "fair" premium to charge for this option, knowing that there's no concrete hedging strategy available to the writer (which would require selling protection against its own default) ? Of course the term "fair" is quite vague and is actually part of my question.

Thanks in advance.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.