Learn OTC derivatives — 36 products, short lessons and quizzes.
Fixed price for floating market price
A commodity swap exchanges a fixed price for a floating one on an agreed volume — barrels of crude, tonnes of wheat, ounces of gold — without either side buying or selling the physical goods. The floating leg is a published price index, usually averaged over each settlement period, and only the net difference changes hands. That separation is the point: a producer or consumer carries on buying and selling physically on its own terms, and lays the price risk off in a separate financial contract that never touches its supply chain.
Open in the app · Commodity · foundational
One party pays a fixed price, the other pays a floating market price for a commodity like oil or gold, on a notional volume — cash-settled with no physical delivery. Neither side is obliged to produce, take or store anything; the swap only moves cash based on where the published price ends up.
Notional is quoted in volume rather than currency — barrels, therms, troy ounces, tonnes. The money at stake is whatever that volume happens to be worth.
The floating leg is usually the average of a published reference price over each settlement period, so a monthly swap settles against the month’s average rather than a single day’s close. Only the net difference between the two legs is paid: if the average sits above the fixed price, the floating payer sends the difference on the full notional volume, and if it sits below, the cash flows the other way.
Monthly averaging is the dominant convention in oil swaps: the floating leg is the mean of every publication of the index on the business days in the calendar month.
Producers and consumers hedge price risk: an airline might fix its fuel costs, or a miner might lock in a selling price for gold. A consumer pays fixed and receives floating, so a rise in the index is refunded by the swap; a producer does the reverse, receiving fixed and paying floating, so a fall in the index is made good. Banks and trading firms take the other side and manage the resulting position in the futures market.
Reference price or index, fixed price, settlement periods, notional volume, and the averaging convention that determines how the floating leg is calculated. The fixed price is agreed at inception and never changes; everything uncertain about the trade sits in the floating leg.
Basis risk appears when the published index does not match the grade or delivery location actually traded. Fixing the price also means giving up gains if the market rallies, and a hedge sized to expected volumes leaves exposure if actual output differs — hedging more than you produce turns the surplus into an outright speculative position.
Commodity swaps sit outside the clearing mandates that cover standard interest rate and credit index swaps, so most stay bilateral, documented under an ISDA Master Agreement with a Credit Support Annex governing collateral.
The swap did not buy a single barrel. It simply refunded the airline the amount by which the index exceeded $95, leaving the fixed price as the effective cost — and it would have clawed back the saving had the index averaged below $95.
Airlines and shipping lines pay fixed to budget fuel, gold and copper miners receive fixed to underwrite a mine plan, and utilities swap gas to fix the input cost behind a regulated tariff. The dealer on the other side is usually a bank commodity desk or a merchant trading house, which hedges its own book in exchange-traded futures.
The app adds a twelve-question bank for Commodity Swap, drawn differently every sitting, and a review queue for whatever you miss.
A subscription adds 3 further sections on Commodity Swap — The pricing window is the contract, Whose price, published where, Grade and location basis — and 12 more questions to its bank.
Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.