Commodity Swaption


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Commodity Swaption 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 Swaption Introduction

A commodity swaption is a European option on a commodity swap. The commodity swaption could be a bullet swaption or an average swaption. An average swaption is similar to Asian option as it is also an option on the average of futures prices. The difference is that a swaption expires before the averaging period starts.

Swaptions are a relatively illiquid product in commodities market. Delta and vega of a swaption is usually hedged with liquid vanilla options and futures. But the curvature risk cannot be hedged with vanilla options.

There are two main sources of swaption market quotes. The first source is the inter-dealer broker market. The second source is the consensus (average) price among the participants of the swaption valuation service.

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 Swaption Valuation

There are a few key ingredients when applying the model to value a commodity swaption: the projection index for the underlying commodity price, the discount curve and the schedule for all the future cash payments of the underlying swap, and the swaption volatility.

The remaining ingredient is the swaption volatility that is probably one of the most difficult input parameter for people using this model. Unlike the vanilla equity option case, option price can be observed due to liquid markets, commodity swaption market is far less liquid, and swaption prices are difficult to observe.