What is a 'Call Swaption'

A call swaption, or call swap option, gives the holder the right, but not the obligation, to enter into a swap agreement as the floating rate payer and fixed rate receiver.

Also known as a receiver swaption.

BREAKING DOWN 'Call Swaption'

Swaptions are similar to other options in that they have a strike price, expiration date and expiration style. The buyer pays the seller a premium for the swaption.

Expiration styles include American, which allows exercise at any time, European, which allows exercise only at the swaption's expiration date, and Bermudan, which sets a series of defined exercise dates. The style is defined at the onset of the swaption contract.

Swaptions come in two main types: a call, or receiver swaption and a put swaption, or a payer, swaption. Call swaptions give the right to become the floating rate payer while put swaptions give the right to become the fixed rate payer.

Swaptions are over-the-counter contracts and are not standardized like equity options or futures contracts. Thus, the buyer and seller need to both agree to the price of the swaption, the time until expiration of the swaption, the notional amount, and the fixed and floating rates.

The strike price indicates the fixed rate to be swapped for the floating rate. At the onset of the swaption, counterparties must agree whether the buyer of the swaption will pay the premium upfront or structure it into the swap rate.

 

Call Swaption Considerations

The buyer of a call swaption expects interest rates to fall and desires to hedge against this possibility. As an example, consider an institution that has a large amount of fixed-rate debt and wishes to increase its exposure to falling interest rates. With a call swaption, the institution converts its fixed-rate liability to a floating-rate one for the duration of the swap. Thus, the receiver swaption can now plan to pay a floating rate on their balance sheet debt and receive the fixed rate from the put swaption position. If interest rates fall, the call swaption can benefit by paying lower interest. Neither position has a guaranteed profit and, if interest rates rise above the call swaption payer's fixed rate, they stand to lose from the adverse market move.

Call swaptions are used to hedge a portfolio containing an interest rate swap but where the underlying asset or liability cash flow is uncertain. These uncertainties arise from a bond call feature and exposure to default risk.

 

Put Swaptions

Put swaptions are the inverse position to call swaptions and are also called payer swaptions. A put swaption position believes interest rates may increase. In order to capitalize or hedge this possibility, the put swaption holder is willing to pay the fixed rate for the chance to profit from the fixed rate differential as the floating rate increases.

RELATED TERMS
  1. Interest-Rate Derivative

    An interest-rate derivative is a financial instrument based on ...
  2. Delayed Rate Setting Swap

    A delayed rate setting swap is an exchange of cash flows, one ...
  3. Swap Rate

    The swap rate is the fixed portion of a swap as determined by ...
  4. Liability Swap

    A liability swap is a financial derivative in which two parties ...
  5. Fourth Market

    The fourth market is a market that trades securities on a private, ...
  6. Plain Vanilla Swap

    A plain vanilla swap is the most basic type of forward claim ...
Related Articles
  1. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  2. Trading

    How To Value Interest Rate Swaps

    An interest rate swap is a contractual agreement between two parties agreeing to exchange cash flows of an underlying asset for a fixed period of time.
  3. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  4. Investing

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  5. Investing

    Understanding Total Return Swaps

    A total return swap is a contract in which a payer and receiver exchange the credit risk and market risk of an underlying asset.
  6. Trading

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  7. Trading

    Hedging with currency swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it with currency swaps.
  8. Trading

    Introduction To Counterparty Risk

    Unlike a funded loan, the exposure from a credit derivative is complicated. Find out everything you need to know about counterparty risk.
  9. Trading

    5 Popular Derivatives And How They Work

    These popular derivative instruments allow investors to hedge, speculate or increase leverage but weigh the risks before taking exposure.
  10. Investing

    CFTC Probes Banks' Use of Interest Rate Swaps

    U.S. regulators are probing banks' trading and clearing of interest rate swaps, which played a central role in the 2008 financial crisis
RELATED FAQS
  1. What is an over-the-counter derivative?

    Learn more about over-the-counter derivatives and how they work with an example of a derivative trade-off exchange. Also ... Read Answer >>
  2. What is the difference between derivatives and swaps?

    Swaps comprise just one type of the broader asset class called derivatives. Read Answer >>
  3. How do companies benefit from interest rate and currency swaps?

    Interest rate and currency swaps help companies manage exposure to rate fluctuations and acquire a lower rate than they would ... Read Answer >>
  4. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
Trading Center