What Is a Put Swaption?
A put swaption, or put swap option, is a position on an interest rate swap that gives an entity the right to pay a fixed rate of interest and receive a floating rate of interest from the swap counterparty. Put swaptions are used by those entities seeking to earn floating rate interest payments in an interest rate swap deal, in expectation of rising rates.
Put swaptions may also be called payer swaptions and can be contrasted with a call (receiver) swaption.
- In a put swaption, the purchaser has the right but not the obligation to enter into a swap contract where they become the fixed-rate payer and the floating-rate receiver.
- Put swaptions are generally used to hedge options positions on bonds, to aid in restructuring current positions, to alter a bond portfolio's duration, or to speculate on rates.
- Also known as a payer swaption, these instruments are purchased by those who expect interest rates to rise.
Understanding Put Swaptions
Put swaptions are an option on an interest rate swap. Swaption market participants are generally large companies and financial institutions. These companies seek to manage some of the risk from debt they have taken on their balance sheets.
The buyer of a put swaption expects interest rates to rise and is hedging against this possibility. As an example, consider an institution that has a large amount of floating-rate debt and wishes to hedge its exposure to rising interest rates. With a put swaption, the institution converts its floating-rate liability to a fixed-rate one for the duration of the swap. Thus, the payer swaption can now plan to pay a fixed rate on their balance sheet debt and receive the floating rate from the call swaption position.
If interest rates rise, the put swaption can benefit by receiving additional interest. Neither counterparty to a swaption has a guaranteed profit and, if interest rates fall below the put swaption payer's fixed rate, they stand to lose from the adverse market move.
Interest Rate Swaps
Interest rate swaps can be valuable transactions for large entities seeking to manage risks from rising interest on the debt they have accumulated on their balance sheets. Put swaptions are one leg of an interest rate swap that involves payment of a fixed rate for the return of a floating rate. Interest rate swaps often involve swapping fixed-rate debt for floating-rate debt for the benefit of managing outstanding debt risk.
Generally, counterparties in an interest rate swap deal will take either the put swaption or the call swaption position. The put swaption buyer pays a fixed rate and receives a floating rate. The call swaption buyer pays the floating rate and receives the fixed rate. In interest rate swaps, the difference between the rates is settled in cash on each date on which debt repayment is due.
Call swaptions are the inverse to put swaptions and may also be called receiver swaptions. A call swaption buyer believes interest rates may decrease and is willing to pay the floating rate for the chance to profit from the fixed-rate differential.
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.