A gas formula swap (gf) is a swap on a natural gas commodity. As these swaps are bespoke, non-standardized and not supported by an exchange, the unit price is set according to a predefined gas pricing formula.
The gas pricing formula itself is defined by the supplier (and sometimes by the government) and is usually (though not always) dependent on the price of alternative energy sources, for example, on the prices of fuel oil, gas oil, etc.
Once you have defined the gas formula swap you can then see more information on each parameter in the selected gas formula that involves fixings. You do this via the Parameter Rates & Fixings window (which is accessed by clicking the Parameter Rates & Fixings button). Moreover, if you have already calculated the instrument, you can also see the actual fixing rates used.
Besides calculating the gas formula rate and present value for the instrument, the system also calculates the:
Delta
This shows the market delta result as an absolute number in the commodity's units.
Each delta result measures the change in the instrument's present value with respect to a small change in the underlying price of commodity X. Knowing the delta per commodity is important because this value is generally used to calculate the amount of underlying X that must be bought or sold to hedge the risk of moves in the price of underlying X.
The delta shown is the market delta calculated using the SD model. This model calculates the delta for each commodity individually by making incremental moves in its future price while maintaining the rest of the term structure constant. This affects the value of the instrument, and therefore the required hedge.
Delta in buckets
The Buckets window for each underlying commodity in the gas formula (which is accessed by clicking the Buckets button next to the relevant commodity in the Results area) shows the delta as distributed over the relevant time buckets.
Which buckets are included depends on which underlying monthly contracts are included for that commodity in the gas formula. This display of delta is useful as it shows you the exposure of the instrument to a change in the individual monthly contracts. This in turn lets you hedge the instrument more effectively over a period of time, i.e., you only need to hedge the appropriate risk in each time bucket.
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According to market convention if the asset is exchange traded its term structure is based on the futures contracts. Subsequently you would usually hedge an instrument on a listed asset using futures contracts, not swaps. However, it is important to note that currently by default SDX Commodities & Energy is showing the delta for all assets (including listed assets) in terms of swaps and not in terms of futures. This will be customizable for listed assets in the near future. |
Pricing a gas formula swap strip in SDX Commodities & Energy
Currently a gas formula swap (gf) can only be priced in the Single Option page.
When defining a gas formula swap:
You must first define the gas formula to be used in pricing it.
You define your own gas formula(s) using the Gas Formula Builder window.
The unit and the currency in the pricing page is taken from the fields in the Formula area of the Gas Formula Builder window.
You have to select the gas formula to be used in pricing this swap before you can define its gas term.
According to market convention, each gas term must be a complete month, for example, dec09, jan10.
After you enter the gas term the system automatically defines the begin and end dates. These dates cannot be manually edited.
As soon as you enter the gas term SDX Commodities & Energy automatically calculates the fixed rate that gives a zero cost instrument (i.e., it is defined to be the same as the calculated gas formula rate, which SDX Commodities & Energy calculates using the defined gas formula). This amount is displayed in the Traded Rate field.
You can then manually change the fixed rate and then recalculate the instrument. This will affect the present value of the swap.
Why would you want to be able to change the fixed rate? There are a number of reasons, but there are two main ones. One is if you agree on a fixed rate on a certain day, but only actually enter the instrument on a later day when the gas formula rate itself has changed. This feature gives you the flexibility to enter the agreed upon gas formula rate. The other reason is that it lets you see the present value of a gas formula swap that you entered into in the past with a specified price per unit.