Swaption

ORE defines the product as follows:

A swaption is an option which gives the buyer the right, but not the obligation, to enter into an underlying interest rate swap. The underlying swap may have varying notional, rates, and spreads during its lifetime, and can be single-currency or cross-currency.

Source: ORE User Guide, Products catalogue, swaption.tex.

ORE splits swaptions into payer and receiver types. A payer swaption has an underlying swap that pays fixed and receives floating. A receiver swaption has an underlying swap that receives fixed and pays floating.

ORE states the European form as follows:

With a European Swaption, the buyer is only allowed to exercise the option and enter into the swap on the expiration date of the swaption.

Source: ORE User Guide, Products catalogue, swaption.tex.

ORE describes the settlement choices as follows:

European Swaption settlement can be either cash or physical delivery of the underlying swap. For cash settlement there are different methods to compute the settlement price (collateralized cash price, par yield curve).

Source: ORE User Guide, Products catalogue, swaption.tex.

ORE states the Bermudan form as follows:

In a Bermudan Swaption, the buyer is allowed to exercise the option and enter into the underlying swap on a predetermined set of dates rather than a single expiration date. The underlying swap may have varying notional, rates, and spreads during its lifetime.

Source: ORE User Guide, Products catalogue, swaption.tex.

An American swaption allows exercise any time between two specified dates.

A swaption is an option on a swap. The buyer pays a premium for the right to enter the swap later. At the exercise date the buyer decides whether the swap is worth entering. A payer swaption gains when rates rise. A receiver swaption gains when rates fall. Physical settlement creates the actual swap. Cash settlement pays the swap value in cash.

The SwaptionData node is the trade data container for the Swaption trade type. The node has exactly one OptionData sub-node and at least one LegData sub-node. Supported exercise styles are European, Bermudan, and American. Swaptions of all styles can carry an arbitrary number of legs. Cross-currency swaptions are supported for all styles. Unless MidCouponExercise is true, at least one full coupon period must follow the exercise date for a European swaption. The same holds after the last exercise date for Bermudan and American swaptions. For swaptions, the payer and receiver legs of the underlying swap are always from the perspective of the party that is long.

A European payer swaption at expiry is worth max(0, V). V is the value of the underlying payer swap at that date. The holder exercises when the swap has positive value. For a plain fixed-versus-floating swap this happens when the market swap rate stands above the fixed rate of the swap. A Bermudan swaption allows one decision per exercise date. The holder compares exercise value with the value of the rights that remain. An American swaption allows exercise any time in a window. Physical exercise creates the underlying swap. Cash settlement pays a settlement amount computed by the chosen method.

• The level of the underlying swap rate against the fixed rate.
• The volatility of that swap rate.
• The discount curve.
• The exercise schedule and the style.
• The terms of the legs, including amortisation and day counts.

A payer swaption gains as the swap rate rises above the fixed rate. A receiver swaption gains as the swap rate falls. Near the money, the value loads on volatility.

A European swaption holds its optionality until expiry. At expiry one decision settles the trade. A Bermudan swaption faces one decision per exercise date. A date that passes without exercise consumes that right. After physical exercise the trade ages as the underlying swap. Its coupons and resets then run to maturity.

A customer locks today's rates for a future swap need. A treasurer hedges the refinancing of a loan. A desk expresses a view on swap rate volatility. The swaption is also the engine of callable structures. In ORE Studio a customer books swaptions to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a long physically settled European receiver swaption on sterling:

<SwaptionData>
    <OptionData>
        <LongShort>Long</LongShort>
        <Style>European</Style>
        <Settlement>Physical</Settlement>
        <ExerciseDates>
          <ExerciseDate>2027-03-02</ExerciseDate>
        </ExerciseDates>
        ...
        <Premiums>
          <Premium>
            <Amount>807000</Amount>
            <Currency>GBP</Currency>
            <PayDate>2021-06-15</PayDate>
          </Premium>
        </Premiums>
    </OptionData>
    <LegData>
        <LegType>Fixed</LegType>
        <Payer>false</Payer>
        <Currency>GBP</Currency>
        ...
    </LegData>
    <LegData>
        <LegType>Floating</LegType>
        <Payer>true</Payer>
        <Currency>GBP</Currency>
        ...
    </LegData>
</SwaptionData>

Source: ORE User Guide, Products catalogue, swaption.tex, listing Swaption data.

A callable swap embeds this optionality, see the Callable Swap note.