A Zero-Tenor Swaption Is Economically a Caplet

Summary

The question asks how to value a swaption that expires in five years and references a swap whose exercise and maturity dates coincide, leaving it with zero tenor. The answer argues that a zero-year interest-rate swap is not a meaningful tradable contract in practice; the shortest practical swap tenors would instead reference a future floating-rate period.

Under that interpretation, the instrument is treated as a caplet: at expiry it pays the positive difference between the reference LIBOR rate and the strike. This reframing points toward caplet valuation rather than valuation of a zero-length swap. The answer is a concise practitioner explanation and does not provide a pricing formula, market conventions, discounting details, or treatment of settlement mechanics. Its LIBOR example reflects the instruments described in the source and should not be read as a complete specification for other rate benchmarks or contract terms.

Key ideas

• A zero-tenor swap is not a standard tradable interest-rate swap.
• A short practical swap references a future floating-rate period.
• A swaption on a zero-tenor swap can be interpreted as a caplet on the reference rate.
• The caplet payoff is the positive excess of the rate over the strike at expiry.

Tags

# Swaption on a swap with 0 year tenor


# Swaption on a swap with 0 year tenor












Any ideas on valuation of IRS swaption on a swap with 0 year tenor?

As an example, we have a 5 year swaption, on expiration it is cash settled; the underlying swap tenor is 0 years with excercise and maturity set on the same day.

## Answer by dm63 (score 1)

https://quant.stackexchange.com/a/21870

from a practitioner perspective, i can say there's no such thing as a 0 year swap (obviously). The shortest tenor that you could trade would be a contract on one month LIBOR or more likely 3 month LIBOR. Then the instrument you are asking about is a 5 year expiration caplet (payoff in 5 years = max (0, LIBOR- strike).)

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.