Put Swaption

What is a sales trade?

A put swaption, or put swap option, is a position on a interest rate swap which gives an entity the right to pay a fixed rate of interest and receive a floating rate interests of the swap counterparty. Put swaptions are used by entities that seek to earn floating rate interest payments under an interest rate swap agreement, in expectation of rising rates.

Sell ​​swaptions can also be called payer swaptions and can be compared to a call exchange (receiver).

Key points to remember

  • In a put swaption, the buyer has the right but not the obligation to enter into a swap agreement in which it becomes the fixed rate payer and the floating rate receiver.
  • Put swaptions are typically used to hedge bond option positions, to help restructure current positions, to change the duration of a bond portfolio, or to speculate on rates.
  • Also known as payer swaption, these instruments are purchased by those who expect interest rates to rise.

Understanding sales exchanges

Put swaptions are an option on an interest rate swap. Players in the swaption market are usually large corporations and financial institutions. These companies seek to manage some of the risk associated with the debt they have incurred on their balance sheets.

The buyer of a put swaption expects interest rates to rise and hedges against this eventuality. Let’s take the example of an institution that has a large amount of variable rate debt and wants to hedge its exposure to rising interest rates. With a put option on a swap, the institution converts its variable rate liability into a fixed rate liability during the term of the swap. Thus, the payer swaption can now plan to pay a fixed rate on its debt on the balance sheet and receive the variable rate of the call swaption position.

If interest rates rise, the sell swaption can benefit by receiving additional interest. Neither consideration to a swaption has a guaranteed profit and, if interest rates fall below the fixed rate of the payer of the put swaption, they stand to lose from the adverse market movement.

Interest rate swaps

Interest rate swaps can be valuable transactions for large entities looking to manage the risk of rising interest on debt they have accumulated on their balance sheets. Sell ​​swaptions are one leg an interest rate swap which involves the payment of a fixed rate for the return of a variable rate. Interest rate swaps often involve exchanging fixed rate debt for floating rate debt in order to manage the risk of outstanding debt.

Typically, counterparties to an interest rate swap agreement will take either the sell swaption position or the buy swaption position. The buyer of the put swaption pays a fixed rate and receives a variable rate. The buyer of the call swaption pays the variable rate and receives the fixed rate. In interest rate swaps, the difference between the rates is settled in cash on each date on which the debt repayment is of.

Call exchanges

Call swaptions are the reverse of placement swaptions and can also be called receiver swaptions. A call swaption buyer thinks interest rates may fall and is willing to pay the floating rate for the opportunity to take advantage of the fixed rate differential.

Take the example of an institution that has significant fixed-rate debt and wants to increase its exposure to falling interest rates. With a swap call option, the institution converts its fixed rate liability into a floating rate liability during the term of the swap. Thus, the receiving swaption can now plan to pay a variable rate on its debt on the balance sheet and receive the fixed rate of the put swaption position. If interest rates fall, the call swaption may benefit by paying lower interest. No position has a guaranteed profit, and if interest rates rise above the fixed rate of the call swaption payer, they risk losing from the adverse market movement.

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