Basically remember this - it will take us two options to replicate the Forward rate agreement.
One to mimic the loss and the other to mimic the gains.
Also remember:
A payer/ receiver are all in “with respect to” the guy on the fixed side.
In a fixed rate payer swap - the guy pays fixed rate and receives floating rate payments.
&
In a fixed rate receiver swap - the guy pays floating rate and receives fixed rate payments.
Long a Call & short a put - replicates a fixed rate payer in a swap.
Short a call & long a put - replicates a fixed rate receiver in a swap.
Question: Why would one take either of the positions above?
1) If the guy - Believes the interest rates will go up, so wants to benefit by buying a call for gains.
Long a call(buyer of a call) = expect to profit from the upward movement in interest rates.
short a put(seller of put) = selling a put, will lead to a loss if the interest rates goes down.( which he thinks will not happen and thus wants to gain from the premium received by selling a put )
2) If the guy - Believes the interest rates will go down, so wants to benefit by buying a put for gains.
Long a put (buying a put) = Expect to profit from the downward movement in interest rates.
Short a call(seller of call) = selling a call, will lead to a loss if the interest rates goes up.(which he thinks will not happen and thus wants to gain from the premium received by selling a call ).