A new Lapped transform domain SAR image despeckling algorithm using a two-state Gaussian mixture probability density function that uses local parameters for the mixture model, is proposed. The use of lapped orthogonal transform (LOT) is motivated by its low computational complexity and robustness to oversmoothing. It is shown that the dyadic rearranged LOT coefficients of logarithmically transformed SAR images can be well approximated using two-state Gaussian mixture distribution compared to Laplacian, Gamma, generalized Gaussian and Cauchy distributions, based on the Kolmogorov–Smirnov (KS) goodness of fit test. The LOT coefficients of speckle noise are modeled using zero mean Gaussian distributions. A maximum a posteriori (MAP) estimator within Bayesian framework is developed using this proposed prior distribution and is used to restore the noisy LOT coefficients. The parameters of mixture distribution are estimated using the expectation-maximization algorithm. This paper presents a new technique to identify LOT modulus maxima which allows us to classify LOT coefficients into the edge and non edge coefficients. The classified edge coefficients are kept unmodified by the proposed algorithm whereas the noise-free estimates of non-edge coefficients are obtained using Bayesian MAP estimator developed using two state Gaussian mixture distribution with local parameters. Finally the proposed technique is combined with the cycle spinning scheme to further improve the despeckling performance. Experimental results show that the proposed method very efficiently reduces speckle in homogeneous regions while preserving more edge structures compared to some recent well known methods.