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Swaptions

A swaption is an option on an interest rate swap. The buyer, for a premium, purchases the right, but not the obligation, to enter into a swap agreement at a specific future date, set strike rate, notional amount, amortization schedule, term, and settlement date. The agreement can either exchange fix rate interest for floating rate interest, or floating rate interest for fixed rate interest. A payer swaption is where the buyer pays the fixed rate interest and receives the floating rate interest.  A receiver swaption is where the buyer receives the fixed rate interest and pays the floating rate interest.

There are three types of swaptions, as follows:

  • American swaptions - The buyer can exercise the option any time during the option period.
  • European swaptions – The buyer can only exercise the option on its maturity date.
  • Bermudan swaptions – The buyer has specified dates during the option period where the option can be exercised.

As with any option, if the swaption is not exercised, it expires worthless.

 

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