In SDX Interest Rates if you choose to cash settle a vanilla swaption or swaption strategy (as opposed to swap settling it), by default the system uses the market default annuity method in order to calculate the market price. The market default is set according to the instrument type and currency1.
For most instruments this is the IRR method (or par cash rate)—in this method the market price is calculated using the market formula for cash settlement whereby the annuity is calculated using a flat yield curve equal to the forward swap rate.
However, for some instruments the default method is not the IRR method, as follows:
For a cash settled forward swaption or an American swaption the system always uses the swap curve annuity method, in which the system calculates the market price as if the instrument was physically settled—this is the market default for these instruments.
For a cash settled vanilla swaption or a swaption strategy on USD or JPY, the price is always calculated as if it was swap settled (according to the market default for these instruments)—that is, SD uses the standard market approach, in which the discount factors for the annuity are computed based on the discounting curve that is used for the pricing of the swaption (and that is set by the Collateralization dropdown list in the pricer itself).
For those instruments for which the default is the IRR method, you can choose to instruct the system to calculate the market price using the swap curve annuity method instead, whereby the system calculates the market price as if the instrument was physically settled, i.e., it calculates the market price of the underlying swap.
You do this in the Settings window > Option/Swap tab > Options tab > Swaption area using the Cash Settle Method radio buttons.
To change the cash settle method used for a vanilla swaption and a swaption strategy where the default is the IRR method:
| 1. | In the ribbon bar click the Home tab > Settings button. |
| 2. | Using the View Profile Settings dropdown list access the user profile for which you want to change the cash settle method. |
| 3. | In the Settings window click the Option/Swap tab > Options tab. |
| 4. | In the Swaption area choose the required cash settle method. |
| 5. | Save the settings to the relevant profile using the Save as MyProfile or Save as Public buttons. |
| 6. | If you want to use the new setting in the system, make sure you select this profile in the Active Profile dropdown list. |