Commodity Forward


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Commodity Forward/Futures Valuation


FinPricing provides valuation models for the following commodity products:

  • Commodity swap (average or bullet)
  • Commodity forward (average or bullet)
  • Commodity futures
  • Commodity cap and floor (average or bullet)
  • Commodity option (average or bullet)
  • Commodity futures option
  • Commodity swaption (average or bullet)
  • Check FinPricing valuation models

1. Commodity Swap Introduction

A commodity forward/futures contract is an agreement between two parties to exchange at some fixed future date a given quantity of commodity for a specific dollar amount, agreed at inception and referred to as the forward/futures price.

Futures are transacted through a futures exchange. This fact implies that futures bear no counterparty risk since both the buyer and the seller deal with the clearing house of the exchange. A commodity futures buyer does not pay any price when purchasing the futures contract, however needs to pay an initial margin to the clearing house.

Futures are standardized in terms of their characteristics (i.e. maturity, quantity of the underlying commodity, quality or variety)

Futures are marked-to-market daily and participants need to adjust their positions if future market price decline from the previous value.

However, some futures exchanges such as LME treat their futures, i.e. base metal futures differently than do other commodity exchanges. Specifically, LME does not mark-to-market their futures daily and settlement happens only on expiration.

Commodity forward contract is traded over the counter (OTC) instead of exchange market. It offers more flexibility.

Commodity futures underlying assets include base metals, crude oil, natural gas, natural gas pipeline, precious metals, and refined products.

The underlying assets of commodity forwards are base metals, crude oil, natural gas, natural gas pipeline, precious metals, refined products, and AESO power.

2. Commodity Forward/Futures Valuation

let F(t,T) be the current future price, at time t, of a future contract with maturity . Then, let F(s,T) be the future price on the following day, at time s. If F(s,T) > F(t,T), then in order not to see their position closed by the clearing house—the futures buyer needs to pay the amount F(s,T) - F(t,T). Observe that if the buyer’s position does not close until the future matures, then the future’s MTM value is F(T,T) - F(t,T) .