Good morning guys,
Another weekend, another study session, huh?
Could someone please tell me if BOTH the receiver swaption and payer swaption have losses capped at premium?
“Buy payer swaption: hedges against rising interest rates, losses are limited to the option premium.”
“Receiver Swaption:An advantage to buying the receiver swaption is that, like an insurance contract, its cost is a known amount paid upfront; potential loss limited to option premium”
BUT
“Receiver Swaption:Potential losses on the receive- fixed swap are time deferred and rate- contingent and therefore are uncertain.”
Thanks!
Swaptions are options on swaps.
A receiver swaption gives the right to received the fixed rate and pay the floating rate. It enables to increasing duration since you will exercice the options if rates go lower then the strike. In that case by exercising the swaption you will be like long a fixed rate bond and short a floating bond with a rate of the later lower than the former.
A payer swaption works conversely and you will exercise it if rates go above the strike and you will than decrease duration (you profit from an increase of rates).
Losses on options (both for receiver and payer swaptions) are time deferred because they materialize if the scenario go against you in the future and rate contingent because they are conditional derivatives (it depends on the future path of rates). You can choses to exercice your right only if rates go in your favor according to a specific given scenario. At the price of a premium.
Buying a receiver or payer swaption (both for receiver and payer swaptions) means you are long the option which means you bought the right to exercise the option by paying a premium.
Hope it helps
thank you! It sure does.
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