Credit Options Question part, protection, reference, specified

malbec

Two types of credit options are: a) Binary Credit Options and b) Credit Spread Options.
One is used as protection when the price of the underlying declines (Binary) and the other is used when the reference spread exceeds the specified spread (Spread). I get that part, but aren’t the two events related? I.e. a decline in the price of the underlying will result in an increase it the spread?
Should these two options be viewed in complete isolation?
What if you are given a question on the exam and they indicate that the price of the underlying declines resulting in an increase in spread and you have to choose which option to use (binary vs. spread).
Thanks

sdada

No, the price can decline due to an increase in the interest rates. Here the credit spread hasn’t changed.

KungFuPanda

There could be an arbitrage between the dollar payout amount from binary option and spread payout amount from credit spread.
Both are insurances against default but with different payout schemes, like a life insurance with different payouts.
Just my two cent…

adehbone

Binary Credit Options - use when you want to protect against a downgrade or default.
Credit Spreads - use when you want to protect against spread changes. Can use options or forwards.
The KEY is to ascertain what event you want to have trigger the payoff.
They are related only in that they help payoff in the event of a decline in bond value, but have different triggers.
Triggers:
Binary - default and downgrade; Credit Spread - specific strike rate.
To answer your question about what happens on the exam if you are given a choice to choose, just keep in mind what the investor wants to strategize against. A decline in value is too vague to make a decision from. You would likely be given additional details about the investor’s preferences.