Swaptions

[alphawave]

I need to get up the learning curve with regards to trading swaptions. Can anyone point me to some resources that might help books, online, courses etc. I've got all the usual options stuff but would like some stuff geared specifically towards swaptions as there doesn't seem to be that much around.

Also does anyone here have experience of actively trading them. Cheers.

 

[Bowball]

a swaption is an option on a swap - the right to enter into a swap at a predetermined rate. remember they're all OTC so structurally a swaption can have an almost infinite combination of pay/receive, maturity, rate, spread, exercise dates (european vs bermudan), etc, etc. you need to know the basics of swaps before you will really understand swaptions. read a book called Mastering Financial Calculations - demonstrates swaps basics, yield curve modelling etc etc

 

[MrGecko]

a swaption is an option on a swap - the right to enter into a swap at a predetermined rate. remember they're all OTC so structurally a swaption can have an almost infinite combination of pay/receive, maturity, rate, spread, exercise dates (european vs bermudan), etc, etc. you need to know the basics of swaps before you will really understand swaptions. read a book called Mastering Financial Calculations - demonstrates swaps basics, yield curve modelling etc etc

I guess they are priced as options on a Bond? So price the swap in terms of a bond, then add up the sum of an option paying/receiving the strike @ each coupon date using your model of the short rate?

I guess you use a binomial method, with each node occuring @ a payment dates... just an idea.

 

[devvvy]

swap is swap, not bond

I guess they are priced as options on a Bond? So price the swap in terms of a bond, then add up the sum of an option paying/receiving the strike @ each coupon date using your model of the short rate?

I guess you use a binomial method, with each node occuring @ a payment dates... just an idea.

Swap is swap not bond. Bond is priced by calculating Present Value of coupons+payment on maturity. Swap is exchange of payments. Take IRS (Interest Rate Swap) for instance, you can have leg#1 = Fixed and leg#2 = floating. "fixed leg" (leg where payment is made on notional at "Fixed" rate determined at start of contract) can be easily computed by discounting future payments of fixed rate. Value of "Floating leg" is determined by notional x "fixing level" (rate fixed for a particular payment period which happens every so often). The difference between value of fixed/floating leg is value of swap.

Now an amatuer perspective of option value is then difference between strike and swap value. A risk-neutral valuation of swaption is however a more complex subject. It takes into consideration volatility, time to maturity, yield curve ... See Black Shoals

 

[Bowball]

you could price it as an option where you simultaneously buy a bond and sell an FRN as this would give you the same cashflows. but personally i think this approach is unnecesary and cumbersome. Devvy is correct, aswap is a swap and not a bond.

in terms of pricing, really not sure which model is used. it is now generally accepted that black scholes meron doent work, but in many option markets the BSM model is used and then adjusted. in an otc market like swaptions the options might all be priced acurately and adjusted using Vasicec model....not that it really makes any difference what model the market uses....provided you're right!

 

[MrGecko]

I know what a swap is.

As bowball said, I would price them as FRN's, with each coupon being the difference between the fixed and floating legs of the swap.