The most widely used swaption is the plain vanilla interest rate swaption. It allows the holder to establish a fixed rate on the underlying swap in advance and have the option of entering into the swap with that fixed rate or allowing the swaption to expire and entering into the swap at the fixed rate that prevails in the market.
Basic characteristics of swaptions.
Uses of swaptions.
Parties often expect to need a swap later and would like to hedge against unfavorable interest rate moves while preserving the flexibility to gain from favorable moves.
A party may wish to terminate an existing swap before expiration. Suppose a party in a swap is paying fixed and receiving floating. If it owned a receiver swaption, it could exercise the swaption, thereby entering into a swap to receive fixed rate a pay a floating rate. It would then have offset the floating parts of the swap, effectively removing any randomness from the position.
As with any interest rate sensitive instrument, swaptions can be used to speculate. Their prices move with interest rates and they contain significant leverage like all options.