I am just trying to understand that if commodity forwards are available, what is the use of a commodity swap. If a farmer wants to hedge his risk, he can do it via entering into a commodity forward, why is the commodity swap required at all ?
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The commodity swap allows the farmer to enter into a series of forwards all at once: so one contract, instead of (say) five separate contracts. Also, the Swap strike will be (approximately) the average of the individual forwards: so from cash-flow perspective, it gives the farmer consistent prices over a prolonged period of time (and some farmers might prefer this). The individual Forwards would all have different strikes, whereas the Swap will have one strike for every month.
answered Jun 8, 2020 at 15:27
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$\begingroup$ I understand that instead of many contracts a swap is all in one and farmer does not have to negotiate with the counterparty at all, but is there anything more advantageous in terms of margins which favors swap over forwards, or both use SIMM model and therefore margins are also the same. Also how is swap giving a series of cashflows if the farmer agrees to a physical delivery at year end. Say he initiates the agreement in Jan-2021 and agrees physical delivery in Dec-2021. So will there be not just a one time cashflow ? $\endgroup$– userxCommented Jun 8, 2020 at 15:44
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$\begingroup$ Commodity derivatives tend to be OTC (unless traded on the CME directly, but those would be futures and options, rather than forwards and swaps). So I'd say that both the Swap and Forward will get the same SIMM treatment. I think the Swap would have physical delivery every month and cash-flow every month. Even if it was customized swap with physical delivery in arrears (only at year end), I believe the Swap cashflows would have to be settled every month still. $\endgroup$ Commented Jun 8, 2020 at 15:47
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$\begingroup$ Interesting, your last point, so are you saying that even if the physical delivery in Jan 2021- Dec-2021 swap happens only in Dec-2021, the cashflows are settled every month which means he has a series of cashflow payments in or out and suppose every month he pays the rent of say tractor or a drone he uses at farm, swap can be a risk management tool for him to keep paying his rent provided the MTM is his side positive. $\endgroup$– userxCommented Jun 8, 2020 at 15:51
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$\begingroup$ Did I understand your last sentence correctly as per my comment above ? $\endgroup$– userxCommented Jun 8, 2020 at 16:02
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$\begingroup$ Thanks I will definitely do that once I go through some literature as well. Actually every literature i have read is only mentioning about one settlement as against a series of cashflows with physical delivery in arrears, can you point me to some literature for this use case ? $\endgroup$– userxCommented Jun 8, 2020 at 16:18