A single look CMS spread option, which has become popular in recent years, is similar to a CMS Spread Option. As in a regular CMS spread option, the underlying is the spread between the yields of two different long term swap rates. However, it only has a single fixing and payment at the end of the period, with a day count fraction described as 1. For example, a 5y 10y-2y CMS spread one-look cap with an end date of 25 November 2014 will have a single fixing on 21 November 2014.
On its fixing date the strike is compared to the spread between the two swap rates as defined in the trade (which is the same as entering into a regular CMS spread option with the underlying rates set in arrears).
When pricing a CMS spread option the user can choose either of the following:
Cap/floor
A cap protects against an increase in the swap rate spread, whereas a floor protects against an inversion or reduction in the swap rate spread. On each fixing date, if the underlying (i.e., the actual difference between the two distinct rates) is above the strike (for a cap) or below the strike (for a floor) the buyer receives a payout. The payout formula for the:
Cap version of a CMS spread option is as follows:
Max((Gearing1*Index1 - Gearing2*Index2) - Strike, 0)
Floor version of a CMS spread option is as follows:
Max(Strike - (Gearing1*Index1 - Gearing2*Index2), 0)
Straddle
A straddle CMS spread option is a liquidity trade. As such it is useful for dealers who want to buy/sell correlation risk.
In addition, adding a condition to a single look CMS spread option makes the instrument cheaper. This is becoming a common way for hedge funds to cheapen a strategy on the shape of the yield curve.
Advantages of a Single Look CMS Spread
This instrument is used in a similar way to a CMS spread option, i.e., as an efficient way to exercise a view on the shape of the yield curve. See also Advantages of a CMS Spread .
Pricing a Single Look CMS Spread
See Pricing a CMS Spread Option in SDX Interest Rates.