SWING OPTIONS

Abstract. Swing options are the main type of volumetric contracts in commodity markets. A swing contract gives the holder the right (but not the obligation) to adjust volume of received commodity at her discretion. Unlike paper assets, trading in physical commodities often takes place over time and therefore involves volume as a second key state variable. Often consumption rates of the commodity are unpredictable and make fixed delivery amounts uneconomic. To mitigate such volume risk, a swing contract gives the buyer the opportunity to manage fluctuating commodity demand levels in exchange for a fixed upfront fee. By exercising her swing up/down rights, the buyer can dynamically match supply and demand levels while hedging her costs. Swing options are widely offered by market makers and used extensively by major energy companies, especially in electricity and fossil fuel markets. Contracts with swing features are available both as stand-alone financial tools, and can also be found embedded within structured physical transactions. 1. Definition and Use. A typical definition of a swing option is as follows. At times n = 1, 2,..., N the buyer is to receive a baseload amount K ̄ of the commodity paying the strike price P ̄. In addition, over the life of the contract, the buyer has Nc ≤ N swing rights to temporaril