Swaptions Help

CFA Level III
#1

Can someone explain to me swaptions. I constantly get confused as to when you would redeem them or not.

Thanks!

#2

To “redeem” a swaption, you would have to be a swaption buyer. Two possible swaption types:

  1. Payer swaption (long / buy)
  • Rights to pay fixed rate, receive floating rate
  • Exercised when rate exceeds the swap fixed rate (i.e. swaption buyer to pay the lower fixed rate)
  1. Receiver swaption (long / buy)
  • Rights to receive fixed rate, pay floating rate
  • Exercised when rate drops below the swap fixed rate (i.e. swaption buyer to receive the higher fixed rate)

Think of them as option to either receive or pay the fixed rate.

2 Likes
#3

A swaption is an option to enter into a swap.

As with any option, you exercise (redeem) them when they’re in the money (i.e., when you’ll make money) and don’t exercise them when they’re out of the money (i.e., when you’ll lose money).

The way to tell whether or not a swaption is in the money or out of the money is to compare its fixed rate with the fixed rate on a current market swap:

  • For a payer swaption (you’ll enter as the fixed rate payer), it’s in the money if the fixed rate is below the market rate, and out of the money if the fixed rate is above the market rate
  • For a receiver swaption (you’ll enter as the fixed rate receiver), it’s in the money if the fixed rate is above the market rate, and out of the money if the fixed rate is below the market rate
3 Likes
#4

Thanks both, very helpful! I understand it now.

#5

Good to hear.

My pleasure.

#6

Thanks for helping me out as well :slight_smile: