233:(OTC), i.e., not cleared or traded on an exchange. Legally, a swaption is a contract granting a party the right to enter an agreement with another counterparty to exchange the required payments. The owner ("buyer") of the swaption is exposed to a failure by the "seller" to enter the swap upon expiry (or to pay the agreed payoff in the case of a cash-settled swaption). Often this exposure is mitigated through the use of collateral agreements whereby variation margin is posted to cover the anticipated future exposure.
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arising from their core business or from their financing arrangements. For example, a corporation wanting protection from rising interest rates might buy a payer swaption. A bank that holds a mortgage portfolio might buy a receiver swaption to protect against lower interest rates that might lead to
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make markets in swaptions in the major currencies, and these banks trade amongst themselves in the swaption interbank market. The market-making banks typically manage large portfolios of swaptions that they have written with various counterparties. A significant investment in technology and human
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of the up- and down-nodes in the later time step, added to which is the discounted value of payments made during the time step in question, and noting that floating payments are based on the short rate at each tree-node. Then (2), the option is valued similar to the
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is typically "read-off" a two dimensional grid of at-the-money volatilities as observed from prices in the
Interbank swaption market. On this grid, one axis is the time to expiration and the other is the length of the underlying swap.
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capital is required to properly monitor and risk-manage the resulting exposure. Swaption markets exist in most of the major currencies in the world, the largest markets being in U.S. dollars, euro, sterling and
Japanese yen.
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conventions. Swaptions can be settled physically (i.e., at expiry the swap is entered between the two parties) or cash-settled, where the value of the swap at expiry is paid according to a market-standard formula.
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The participants in the swaption market are predominantly large corporations, banks, financial institutions and hedge funds. End users such as corporations and banks typically use swaptions to manage
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early prepayment of the mortgages. A hedge fund believing that interest rates will not rise by more than a certain amount might sell a payer swaption aiming to make money by collecting the premium.
402:, of the swap value at the node. For both steps, the discounting is at the short rate at the tree-node in question. (Note that the Hull-White Model returns a
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Bermudan swaption, in which the owner is allowed to enter the swap on multiple specified dates, typically coupon dates during the life of the underlying swap.
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that would apply between the maturity of the option—time m—and the tenor of the underlying swap such that the swap, at time m, would have an "
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European swaption, in which the owner is allowed to enter the swap only at the start of the swap. These are the standard in the marketplace.
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289:. Moneyness, therefore, is determined based on whether the strike rate is higher, lower, or at the same level as the forward swap rate.
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gives the owner of the swaption the right to enter into a swap in which they will receive the fixed leg, and pay the floating leg.
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To use the lattice based approach, the analyst constructs a "tree" of short rates—a zeroeth step—consistent with today's
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gives the owner of the swaption the right to enter into a swap where they pay the fixed leg and receive the floating leg.
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American swaption, in which the owner is allowed to enter the swap on any day that falls within a range of two dates.
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Length of the option period (which usually ends two business days prior to the start date of the underlying swap),
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In addition, a "straddle" refers to a combination of a receiver and a payer option on the same underlying swap.
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that describe the movement of interest rates over time. However, a standard practice, particularly amongst
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The frequency of observation for the floating leg of the swap (for example, 3 month Libor paid quarterly)
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Derivatives: A Comprehensive
Resource for Options, Futures, Interest Rate Swaps and Mortgage Securities
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406:: the same logic is applied, although there are then three nodes in question at each point.) See
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The fixed rate (which equals the strike of the swaption) and payment frequency for the fixed leg
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Exotic desks may be willing to create customised types of swaptions, analogous to
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granting its owner the right but not the obligation to enter into an underlying
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There are two types of swaption contracts (analogous to put and call options):
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Valuation of
Interest-Sensitive Financial Instruments: SOA Monograph M-FI96-1
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The
Relative Valuation of Caps and Swaptions: Theory and Empirical Evidence
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Interest Rate Models - Theory and
Practice with Smile, Inflation and Credit
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of calculation is more important, is to value
European swaptions using the
659:(Advanced Fixed Income Analytics 4:5), Prof. D. Backus and Prof. S. Zin,
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Alternative
Valuation Methods for Swaptions: The Devil is in the Details
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There are three main styles that define the exercise of the swaption:
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Longstaff, Francis A., Pedro Santa-Clara, and
Eduardo S. Schwartz.
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In valuing
European swaptions using the Black model, the
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Lattice model (finance) § Interest rate derivatives
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Option granting the owner the right to a financial swap
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The valuation of swaptions is complicated in that the
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Valuation of fixed income securities and derivatives
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Valuation of Fixed Income Securities and Derivatives
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Size and Uses of the Non-Cleared Derivatives Market
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Notional amount (with amortization amounts, if any)
60:. Unsourced material may be challenged and removed.
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357:Volatility smile § Implied volatility surface
657:Black-Scholes and binomial valuation of swaptions
178:The buyer and seller of the swaption agree on:
630:Blanco, Carlos, Josh Gray and Marc Hazzard.
188:The terms of the underlying swap, including:
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661:New York University Stern School of Business
557:(2nd ed. 2006 ed.). Springer Verlag.
497:Frank J. Fabozzi, CFA (15 January 1998).
448:. Harvard Business Review Press. p.
120:Learn how and when to remove this message
296:value swaptions by constructing complex
648:Martingales and Measures: Black's Model
576:(1st ed.). John Wiley & Sons.
432:
553:Damiano Brigo, Fabio Mercurio (2001).
638:Basic Fixed Income Derivative Hedging
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503:. John Wiley & Sons. pp. .
472:Bank of International Settlements -
355:may then be made for moneyness; see
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58:adding citations to reliable sources
342:on a swap. Here, as mentioned, the
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229:The swaption market is primarily
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45:needs additional citations for
650:Dr. Jacqueline Henn-Overbeck,
346:is the forward swap rate. The
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269:Bond option § Valuation
392:approach for equity options
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474:OTC derivatives statistics
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572:David F. Babbel (1996).
440:Fred D. Arditti (1996).
366:and short rate (caplet)
237:Swaption exercise styles
203:There are two possible
294:quantitative analysts
54:improve this article
652:University of Basel
146:interest rate swaps
525:"Option valuation"
275:at-the-money level
218:interest rate risk
676:Options (finance)
642:Financial-edu.com
609:978-1-883249-25-0
564:978-3-540-22149-4
510:978-1-883249-25-0
305:short-rate models
292:Addressing this,
169:receiver swaption
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52:Please help
47:verification
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530:. Fall 2000
364:yield curve
353:Adjustments
317:Black model
670:Categories
600:John Wiley
547:References
459:0875845606
384:discounted
380:Hull-White
368:volatility
348:volatility
311:, to whom
205:settlement
80:newspapers
69:"Swaption"
396:moneyness
336:underlier
325:Bermudan-
321:American-
267:Compare:
263:Valuation
18:Swaptions
594:(1998).
415:See also
134:swaption
110:May 2010
534:May 12,
319:. For
309:traders
94:scholar
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484:ISDA -
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372:Ho–Lee
138:option
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528:(PDF)
427:Notes
313:speed
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536:2014
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378:and
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