An option on a floor. In other words, a floortion is an option to buy or sell an interest rate floor whereby the holder has the right, without the obligation, to purchase or sell a floor with an agreed-upon strike rate on (if the floortion is European-style) or before (if the floortion is American-style) a given date against a specified premium. An investor purchasing a floortion (which confers on him the right to enter into an interest rate floor) would gain in case the floating interest rate on the underlying instrument (a note) drops below a specific level. Otherwise, that investor can simply choose to refrain from purchasing the interest rate floor. As the floortion goes unexercised, the investor loses the premium, but at the same time, he is said to have hedged interest rate risk and volatility risk.

For example, a two-year floor has a premium of 100 basis points. An investor could currently buy an at-the-money six-month floortion for 10 basis points. The floortion is an option to buy the floor at or before the expiration date at which the option’s life ends. If the floor is in-the-money at expiration, the holder of the caption would exercise the option to purchase the floor for 100 basis points, whereby gaining the amount by which the floor is in the money (say 20 basis points, for a floor worth 120 basis points). The total cost to the floortion buyer is, therefore, the floortion cost plus the floor cost, i.e., 100 plus 10 or 110 basis points). The additional cost an investor incurs for a floortion is the price he pays against being able to hedge or mitigate downside interest rate risk at a future date.

The floortion is also known as an interest rate floortion.