Definition
A swaption gives the buyer the right (but not obligation) to enter a swap on specified terms at a future date. A payer swaption gives the right to pay fixed (profit when rates rise). A receiver swaption gives the right to receive fixed (profit when rates fall). Swaptions are heavily used by mortgage servicers to hedge prepayment risk and by corporates planning future debt issuance.
lightbulb Example
A company planning to issue fixed-rate debt in 6 months buys a 6-month payer swaption at 4.5% strike. If 5-year swap rates rise to 5.0%, the company exercises, entering a swap that effectively locks in borrowing at 4.5%.
verified_user Key Points
- Option to enter a future swap
- Payer swaption profits from rising rates
- Receiver swaption profits from falling rates
- Widely used by mortgage servicers and corporate treasurers