21. How does the credit exposure of a long OTC put option on XYZ stock change when the stock price decreases?

A. Increases

B. Decreases

C. Doesn't vary with underlying stock price

D. There is no credit exposure on long options

Correct answer is Afficeffice" />

A is correct. Credit exposure from long positions in OTC options, assuming that the credit quality of the counterparty remains constant, is driven by the level of the contingent future liability, i.e. the larger the expected future claim against the counterparty, the larger the credit risk. 

The value of the put at expiration is defined as max(X-S,0) where X=strike price and S=spot price. Therefore, a long put option increases in value as the stock price decreases.  Thus, the expected liability of our counterparty is increased (choice A).

Reference:  Measuring and Managing Credit Risk, De Servigny and Renault, 2004.

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