Swaptions

CFA Level III Derivatives
#1

  1. Does a buyer of payer swaption pay a premium? I read something that said payer swaptions receives a premium rather than psy a premium

  2. Is a payer swaption the same as writing a receiver swaption?

#2

The buyer of any kind of option pays a premium.

Is buying a call the same as writing a put?

Is buying a put the same as writing a call?

#3

I think of it exactly like how s2000magician put it: like options.

  1. If we BUY a payer swaption → we’re paying fixed; receiving floating.
  2. If we SELL a payer swaption → we’re paying floating; receiving fixed.
  3. If we BUY a receiver swaption → we’re receiving fixed; paying floating.
  4. If we SELL a receiver swaption → we’re receiving floating; paying fixed.

Ask yourself, where do we think rates will go? Just like equity options:

We buy calls (payer swaptions) and sell puts (receiver swaptions) if we think rates are up ↑

We buy puts (receiver swaptions) and sell calls (payer swaptions) if we think rates are down ↓

I tend to think of it like an options matrix (a ‘swaptions matrix,’ if you will): Connect the corners!

CALL/PAYER (‘Pays Fixed’) PUT/RECEIVER (‘Receives Fixed’)

BUY

  • Pay fixed rate Pay floating rate
  • Rec floating rate Rec fixed rate
  • ‘Selling bonds’ aka Decreasing Duration ‘Buying bonds’ aka Increasing Duration
  • GOAL: Int. Rates/New SFR to go up ↑ GOAL: Int. Rates/New SFR to go down ↓

SELL

  • Pay floating rate Pay fixed rate
  • Rec fixed rate Rec floating rate
  • ‘Buying Bonds’ aka Increasing Duration ‘Selling Bonds’ aka Decreasing Duration
  • GOAL: Int. Rates/New SFR to go down ↓ GOAL: Int. Rates/New SFR to go up ↑

Hope this helps!

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#4

Thinking of swaptions like options makes a lot of sense because swaptions are . . . wait for it! . . . options!

#5

Thank you! I will have to add this to my memory repertoire! I knew okay but taking too long to think about the directions.

Now its simple… Payer Swaption is a call and recieve swaption is a put lol…

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#6

Not if you issued a bond. If interest rates expected to lower, a reciver swaption is adding a call to it. And in vice versa, a payer swaption is removing it haha

#7

Well yes, if you issue a bond, you’re on the other end of the zero-sum game.

#8

125 - I believe you are right. Just to be clear.

If you sell a receiver-swaption (in essence buying payor swaption), you receive premium. As opposed to buying payor option.

2019 CFA Cirriculum/Vol 5/Pg 402

#9

No, no, no, no, no!

These are not remotely the same, in essence or in any other way.

#10

yes buyer pays the premium

#11

What does this mean? Receiver swaption is adding a call to it?

#13

If you issue a fixed-rate, straight bond, you can buy a receiver swaption which gives you the right to receive a fixed rate and pay a floating rate. In effect, you’ll have an option to convert your fixed-rate bond to a floating-rate bond, which is similar to having a call option.

#15

When you say you, it means issuer and not investor, right?
Secondly if he enters into the swap to receive fixed and pay floating, how is it a call option?

#16

You issue a fixed-rate bond. You’re the issuer.

You buy a receiver swaption.

If rates fall, you exercise the swaption, entering into a receive fixed, pay floating swap.

The net effect of exercising the swaption and entering into the swap is that you’re now paying (net) a floating rate.

It’s not a call option (nor did I say that it is), but it’s similar to a call option. If you’d issued a callable bond, then you might exercise the option when rates are down, and pay off the bonds. Where will you get the money to pay off the bonds? Probably from issuing new bonds with a lower coupon. So you’ve merely lowered your coupon payment. Same with the swap: you’re now paying a lower net rate than the old fixed rate.

#17

Will writing a payer swaption add duration?

#18

What do you think?

Why do you think that?

#19

I know for sure that buying a payer swaption (right to pay fixed and receive floating) will reduce duration…
Writing a payer swaption means an obligation to enter into a pay floating and receive fixed swap…hence I feel it should add duration…But I got consfused about the obligation part…Not sure if I am correct…

#20

Duration’s a zero sum game. If buying a payer swaption reduces your duration . . . .

#21

Then writing a payer swaption will add it…!

#22

Voilà!

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