Commodity Swap
FinPricing offers:
Four user interfaces:
- Data API.
- Excel Add-ins.
- Model Analytic API.
- GUI APP.
Commodity Swap 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 swap is an agreement between two counterparties to exchange cash flows determined by the price of an underlying commodity.
Similar to an interest rate swap, a commodity swap is typically structured with a fixed leg, which provides the holder with
a stream of fixed payments based on a prearranged price for the commodity, and a floating leg, for which the cash flows are calculated
from the forward prices of the underlying futures contracts.
In the case of a bullet swap, each floating leg cash flow is determined from a single price, such as the closing price on the futures
contract maturity date (or possibly the average closing price over the final three days). For an average swap, the floating leg payments are
based on the average price over a specified period, such as the business days in the first month of the current contract.
The floating price may be the spot price of the specified commodity, the price for the nearest futures contract, an average of
spot prices for the underlying commodity during the payment period or an average of spot and futures prices. If all floating prices
are determined from a single price, the product is called a bullet swap. Otherwise, it is called average swap.
Commodity swaps are financially settled and do not involve any physical delivery. They are over the counter (OTC), customized
transactions and suitable for hedging purposes. Also observe that the existence of a reliable index is essential to determine the payments
on the floating leg. .
The underlying assets of a commodity swap could be base metals, crude oil, natural gas, natural gas pipeline, precious metals,
refined products, or AESO power.
| 2. Commodity Swap Valuation |
Unlike other asset classes such as equities, commodity derivatives are typically written on contracts for future delivery.
Furthermore, contracts on the same underlying commodity that expire on different dates are not fungible, as they are effectively
different assets. This presents unique challenges when pricing products that depend on multiple points on the forward commodity curve.
A futures curve is used when pricing derivatives written on natural gas, crude oil and power, while a base metal curve or a precious metal curve is used to for valuing metal contracts.
The largest source of uncertainty is the forward commodity curve, from which the forward prices of the underlying commodity contracts are obtained.