When a Midcurve Swaption Decision Becomes Binding

Summary

The document clarifies when the holder of a midcurve payer swaption must decide whether to enter the underlying forward-starting swap. The answer says the decision occurs at the option’s expiry, using the example of a one-year option on a five-year swap beginning five years later. If exercised, the holder takes on the swap at the strike terms then; the later market rate does not provide another choice to enter or decline.

After exercise, the position remains exposed to rate changes until the swap starts and during the swap’s life. Closing the position at a later date can realize a loss if rates have moved unfavorably, while holding it leaves open the possibility of a favorable rate move. The brief response offers no valuation details or discussion of settlement conventions, so its timing explanation should be read in the context of the specific contract terms.

Key ideas

• The holder decides whether to exercise at the swaption’s expiry.
• Exercising commits the holder to the underlying swap on its specified terms.
• Changes in rates after expiry affect the value of the resulting position.
• The holder may close the position later or retain its exposure, subject to contract terms.

Tags

# Expiry of a midcurve swaption


# Expiry of a midcurve swaption












Have a logical question - let me paint a picture.

I have a 1y5y5y Midcurve Payer Swaption, and at Expiry the swaption is ITM (say the 5y5y rate is 4% and my strike is 3%).

then 5 years after expiry (6y since we bought the swaption), the actual 5y rate is 2%.

Do we decide to enter into the forward starting swap at expiry of the option (i.e 1 year), and even thought the fwd rate was 4% at expiry, when 5 years passes, and the 5y spot rate is 2%, we are still paying 3%(obviously making a loss), or do we have up until the actual start of the swap(in 6 yrs) to decide if we want to enter.

thanks.

## Answer by Randor (score 1)

https://quant.stackexchange.com/a/74016

Decide at 1year.

At 6y, if you close out, you lost , but if you stay with it , then you might be lucky and rates rise and you end up making money

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