Swaption

A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on interest rate swaps.

There are two types of swaption contracts:

• A payer swaption gives the owner of the swaption the right to enter into a swap where they pay the fixed leg and receive the floating leg.
• A receiver swaption gives the owner of the swaption the right to enter into a swap in which they will receive the fixed leg, and pay the floating leg.

In addition, a "straddle" refers to a combination of a receiver and a payer option on the same underlying swap.

The buyer and seller of the swaption agree on:

• the premium (price) of the swaption
• length of the option period (which usually ends two business days prior to the start date of the underlying swap),
• the terms of the underlying swap, including:
• notional amount (with amortization amounts, if any)
• the fixed rate (which equals the strike of the swaption)
• the frequency of observation for the floating leg of the swap (for example, 3 month Libor paid quarterly)