What is a swaption straddle and when would a trader use it?

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AcadiFi · Accepted Answer

A swaption straddle is the simultaneous purchase of an at-the-money payer and receiver swaption with the same strike, expiry, and underlying swap. It is a pure volatility play: profits if rates move significantly in either direction, loses if rates stay near strike.

Payoff at expiry: Payer + Receiver = |S_T - K| x PVBP. Always non-negative because one leg is always in the money (unless S_T = K exactly).

By put-call parity, at-the-money-forward (K = F) means payer value = receiver value, so straddle premium = 2 x payer premium. Swaption dealers typically quote the ATM straddle price in basis points of notional; this is the market's measure of swap rate volatility over the option's tenor.

Example: Coldwater Capital expects the Fed's next decision to be 'high variance' - either aggressive cuts (rates drop 100 bps) or aggressive holds with hawkish guidance (rates rise 50 bps). They buy a 3-month ATM straddle on the 5-year swap at K=F=4.60%, PVBP=4.35. Premium might be 75 bps of notional for 15% implied vol.

Breakeven: at expiry, need |S_T - 4.60%| x 4.35 > 0.75%, i.e., S_T > 4.77% or S_T < 4.43%. Any outcome in between means a loss.

In swaption Greek terms, the straddle is delta-neutral, long vega (gains if implied vol rises), long gamma (gains from large realized moves), and loses theta daily.

```mermaid
graph TB
  A[ATM Straddle] --> B[Long payer]
  A --> C[Long receiver]
  B --> D[Profits if rates rise]
  C --> E[Profits if rates fall]
  D --> F[Vol bet]
  E --> F
```

What is a swaption straddle and when would a trader use it?

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