August 2005

At the Money Swaptions– Sajiv Shrivastva

AT THE MONEY SWAPTIONS
 Product Background

Swaption
 A swaption is the right, but not the obligation to enter into an
interest rate swap. As with all options a premium is paid to
obtain this right.

 A receiver (call) swaption: the right to receive fixed in the

underlying swap

A payer (put) swaption: the right to pay fixed in the

underlying swap
AT THE MONEY SWAPTIONS

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 Product Background

Optionality on Swaptions
 A European Swaption can only be exercised on the expiration
date.
— Given only one exercise date and a known underlying swap
maturity, European swaptions are often referred to as “1 into
2” whereby the first number refers to the length of the option
period and the second to the length of the underlying swap.
E.g. A 1 into 2 yr swaption translates into an option into
entering a 2 year swap in one year.

 A Bermudan Swaption has periodic exercise dates.

— In this type of option, the tenor of the underlying swap
depends when/if the option is exercised. A “5NC1” refers
to a final maturity date on the underlying of 5 years and
no call dates on the option for the first year
— After 1 year, the owner may exercise periodically (lets
assume quarterly). If the owner exercises periodically
(let’s assume quarterly). If the owner exercises after 2
years(1 year after the no-call period), the swap tenor
would be 3 years.
AT THE MONEY SWAPTIONS

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 Product Background

At the Money (ATM) Swaptions

 The scope of this presentation will now focus on At the Money
Swapations
— These options will be European and will be right at the
money. (Current Forward price = Strike Price, The
option on the swap is currently at the expiration date)

 All price testing positions and prices are tested in the

following grid format.

Swap
Tenors

Option 1 2 3 4 5 6 7 8 9 10 12 15 20 25 30
7D 4.29 8.99 14.27 19.32 24.50 28.52 32.28 35.89 39.27 42.45 48.98 57.74 67.78 76.50 83.27
14D 5.50 12.23 19.49 26.43 33.57 39.06 44.19 49.10 53.72 58.05 66.98 78.96 92.68 104.60 113.86
Expiry 21D 6.27 14.37 22.99 31.22 39.71 46.20 52.25 58.04 63.48 68.58 79.12 93.22 109.39 123.44 134.34
1M 6.85 16.03 25.64 34.86 44.35 51.56 58.26 64.70 70.78 76.39 88.08 103.69 121.63 137.20 149.27
2M 9.69 23.93 37.86 51.13 64.73 75.27 85.07 94.51 103.33 111.58 128.57 151.25 177.30 199.96 217.51
3M 12.45 30.17 47.12 63.39 79.87 92.86 104.96 116.57 127.46 137.64 157.67 183.74 214.18 240.73 260.93
6M 20.23 46.41 70.28 93.19 115.81 134.69 152.34 169.22 185.04 199.85 226.74 260.51 300.89 336.33 362.50
9M 27.37 58.69 86.72 115.07 143.10 166.44 187.99 209.19 229.19 247.97 279.86 318.73 365.48 407.74 438.65
1 Yr 33.44 67.83 100.82 133.16 164.93 192.33 218.13 243.06 266.74 285.85 322.30 366.92 417.73 465.47 500.23
1.5Yr 42.40 82.73 122.41 160.87 198.15 231.01 261.51 290.62 317.97 343.54 386.05 436.68 496.18 551.85 591.90
2 Yr 50.21 95.57 140.39 183.15 223.98 261.09 295.85 326.58 358.61 386.65 434.01 490.71 556.44 618.42 662.86
3 Yr 59.72 114.07 165.74 215.29 261.66 304.21 343.94 380.99 415.63 447.39 499.39 560.08 633.76 704.15 754.90
4 Yr 65.84 125.65 182.43 235.88 286.03 333.30 373.07 413.01 449.52 483.21 537.82 600.23 675.07 749.25 802.25
5 Yr 68.98 132.21 191.20 246.88 299.05 346.83 391.40 431.91 469.15 503.26 558.97 621.50 694.39 770.84 825.61
7 Yr 70.79 135.16 195.52 251.61 302.91 350.31 394.00 434.00 470.92 504.13 558.92 620.50 693.45 771.08 827.48
10 Yr 67.86 128.99 185.66 237.75 285.47 329.26 369.19 405.79 438.39 467.88 515.96 567.28 647.50 724.39 780.68
15 Yr 56.43 108.47 157.14 201.50 242.54 279.79 313.79 344.98 372.91 398.05 443.51 496.05 583.70 645.90 689.84
20 Yr 45.98 88.49 127.89 163.67 196.36 226.97 255.06 280.77 304.42 325.74 369.97 426.73 498.17 548.10 581.00
AT THE MONEY SWAPTIONS

30 Yr 28.95 55.54 79.90 102.27 122.38 141.79 159.71 176.19 191.18 204.67 233.19 270.09 317.84 352.05 375.71

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 Swaption At The Money (ATM) pricing

Pricing Parameters
 Forwards Surface (JPM)

 Forward Yield Volatility (JPM/Broker)

 Break Even Volatility (JPM/Broker)

— Volatility described as the basis point move in the underlying
needed per business day over the life of the option for return
to offset time decay. Implicit is the assumption that yield
moves affect volatility

 Vega Surface (JPM)

— The change in present value of the trade for a one percent up
movement in forward percent yield volatility

 Option premium (Broker)

— Price of the Option
AT THE MONEY SWAPTIONS

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 Swaption At The Money (ATM) pricing

Pricing Methodology

1) Obtain premiums from various brokers

2) Reduce noise from broker premiums using standard outlier
adjustment methodology
3) Convert outlier adjusted premiums in to break even
volatilities
4) Using straight line interpolation to obtain break even points
along the 2, 9 and 18 month tenors
5) Convert interpolated break even volatilities back into
premiums
6) Similar to standard price testing, price test JPM premiums to
broker premiums.
AT THE MONEY SWAPTIONS

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AT THE MONEY SWAPTIONS

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