A CDS option (option on a credit default swap) that grants the holder the right to sell credit protection on a specific reference entity during a predetermined future period starting at some date earlier against a preset premium.
For example, firm (x) might buy a put CDS on firm (y) for four years starting in one year for 250 basis points per annum. If firm (y) doesn’t default during the option’s life (1 year), the option expires worthless. Otherwise, firm (x) will exercise the option in case the market price of four-year protection is less than 250 basis points at expiration.
