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.
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Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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