Can someone help me figure out why buying a 2.3% receiver swaption when rates rise above 3.3% is a good idea? To my understanding, if you buy a 2.3% receiver swaption and rates rise above 3.3%, you locked in a lower rate. How is that beneficial if it expires worthless?
Tough one, but if you take a good look (and if I am correct about the holistic approach over all 3 alternatives), maybe it might not be that technically incorrect.
If the rates rise above 3.3%, e.g. to 4.0%, then:
- alternative 1 generates loss of 1.5%
- alternative 2 (in best case) generates loss of 0.7% + net premium → under presumption buyer would not exercise receiver swaption and the other buyer would activate payer swaption.
- alternative 3 would generates solely the premium loss if he leaves the swaption unexercised
This is just mine hard logic, but am not 100% sure, and besides, would not rely on notes based on slides.
So essentially you’re saying that Option 3 generates the least loss of the 3 options. Makes sense. Was poorly worded by Kaplan Schweser in that sheet. But thanks that’s helpful!