Swaption

A swaption (a portmanteau of "swap" and "option") is an option granting its owner the right but not the obligation to enter into an underlying swap on specified terms at a future date. In practice the term is most commonly used for options on interest rate swaps, where the holder has the right to enter into a fixed-for-floating interest rate swap.

Swaptions are traded over the counter between institutions and are used by banks, insurance companies, corporations and others to manage interest rate risk or to take speculative positions on future interest rates. The basic contract may give the right to pay fixed and receive floating (a "payer" swaption) or to receive fixed and pay floating (a "receiver" swaption), and can be structured with various exercise styles (European, Bermudan or American) and either physical or cash settlement.

Swaption valuation typically relies on option pricing models such as the Black model or interest rate models implemented on a lattice or tree to describe the evolution of future interest rates.