An option on a swap, that is, an option contract which allows the holder to enter into a swap. An investor seeks this combination when he needs to manage some sort of risk later on with a swap without having to commit thereto today. Therefore, the investor uses options thereby he has the right to buy the swap should a need for that arise in the future. Swaptions are usually based on a floating rate such as LIBOR, though swaptions on other floating rates also do exist. Swaptions can be settled in physical or cash. Exposure to position risk in the physical settled swaption lasts till the swap finally matures, while the cash-settled swaption simply terminates after option expiration.
Two different types of swaption are usually entered into: call swaption and put swaption.
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