Implement swaptions in SimCorp Dimension

6 of January 2022

👓 Recently we were working on implementation of swaptions in SimCorp Dimension, and would like to share a few important moments to take into account when you deal with such an interesting derivative.

📚 First of all, as you might already see it from the instrument’s name, it’s a combination of option and swap. Swaps refer to derivatives categories, though mathematically they can be represented as long & short bond positions. Unlike bonds, they have many specific details in valuation, starting from duo yield curves stripping algorithm and finishing with multiple legs inflation linked swaps (which might even have more than 2 legs). They represent a powerful instrument type for interest rate risk hedging. As it is OTC instrument – its credit risk is often a subject to clearing house processes (such swaps are called the cleared ones). In the same time, there are also bilateral swaps which might be covered by specific collateral. If all these details do not make it yet a challenge for a precise valuation – then once such instrument type is integrated with option characteristics – we get a swaption. The options world significantly differs from swaps, as they are not linear instruments, and might involve absolutely different valuation models, based on volatility curves, exercise types (e.g. American , European ,Bermudan) and strike peculiarities. As the result, a swaption experiences all kinds of key ratios including Greek ratios (i.e. characteristics of options).

Especially you have to be careful with a market exposure definition for this instrument type, as it is used for aggregation of different durations. Besides, different market regulations might define the swaption’s market exposure differently for risk measurement. The challenging part here is that in Dimension swaptions are represented in a single line whereas swaps use e.g. 2 lines (i.e. dedicated to 2 legs).

🧊 Please, also notice, that SimCorp Dimension-wise the best up-to date module to handle swaptions’ static and transaction data is Trade Manager. In case you still use the APL swaption module (i.e. a previous generation of Dimension solutions for static and transaction data) – then don’t forget to check that APL module has a complete underlying swap module activated (for exact valuation and reporting figures).

🏷️ Also, you might pay attention to price methods, as for example, there are some interesting ones which might even use the implied volatility in case the volatility curves are not maintained in-house, whereas the swaptions quotes/prices are imported from the external data vendors.

📧 If you still have questions regarding swaptions implementation in SimCorp Dimension – feel free to contact Unitso team, and we will be glad to assist you further.