It sounds like the name of the dashing options trader who becomes Archie's rival for a four-episode arc on Riverdale. But, no, a call swaption is a clever name that only finance people could come up with to refer to a combination of an interest rate swap and an option.
This strategy involves a player (usually a bank or large corporation) who wants to have the ability to hedge against falling interest rates. Borrowers who have a floating interest rate can swap with another party to a fixed rate to make costs more predictable. Or they can take advantage of lower interest rates and swap a fixed interest rate for a floating one. The option part comes in because it gives the holder the right to enter into a swap agreement as the floating rate payer and the fixed rate receiver.
A strike price of the option is established, (the price at which action will be taken), an expiration date, and the fixed and floating rates. Once the strike price is reached, the fixed interest rate can be swapped for a floating interest rate.
If this sounds like a lot of gibberish, an example here might be helpful. Let's say Knowitall University is watching the market closely and expects interest rates to fall. They have a large amount of fixed interest rate debt and want to hedge, so they can take advantage of the falling interest rates. So they enter into a call swaption to convert its fixed rate debt to a floating rate for the duration of five years. Now they can pay a variable interest rate on their debt (which they hope means the rate will go lower). If interest rates rise, they will lose out.
Related or Semi-related Video
Finance: What Is a Put Option?83 Views
finance a la shmoop what is a put option? hot potato hot potato
ow ow! yeah remember that game well nobody wanted the potato, poor thing. the
players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]
of work the same way. a put option is the right or option or choice to sell a
stock or a bond at a given price to someone by a certain end date.
all right example time. you bought netflix stock at the IPO a zillion years
ago at $1 a share. that's you know splits adjusted. all right now it's a hundred
bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in
California that would be a tax of something like almost 40 bucks. well the
stock was a hundred but you keep only something like 60. feels totally unfair.
right so you really don't want to sell your stock but you're nervous about the [graph shown]
next few months that Netflix will crater for a while and go down ten
maybe twenty dollars. longer term though you think it'll hit 300. so this is the
perfect setup to maybe look at buying some put options on Netflix. if the stock
goes down your put options go up. with Netflix volatile but at a hundred bucks
a share ,you look up the price of an $80 strike price put option expiring in
December, and you know that's mid-september now .for five bucks a share
you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]
term life insurance. you pay the five dollars a share in the stock goes down
to 82 by mid December, worst of all worlds. well not only did you lose the $5
a share but your stock has lost $18 in value. but had Netflix really cratered
and gone to say $60 a share well you would have exercised your put and sold
your shares at 80 bucks. well those put options you paid $5 for
would be been worth 15 bucks a share. in buying that put option you've [equation shown]
guaranteed that your loss will be no more than a $75 value for your Netflix
position at least for that time period and ignoring taxes. well remember that
options expire after December whatever like the third Friday of the month it's
usually when options expire, you then have no protection and your shares float
along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]
raunchy. yeah well that's naked put options.
that's what they really are people.
Up Next
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
What is a strike price? Strike prices are used in conjunction with options. Calls and puts give investors the right to buy or sell stocks at predet...