What is a swap?
An airline needs jet fuel in 3, 9, and 15 months. Instead of guessing future prices, it agrees a fixed price today with a swap dealer.
At each settlement date, the market price is compared to the fixed price. If the market is higher, the airline receives the difference. If lower, it pays. Either way, the airline knows its effective cost upfront.
How is the fair fixed price found?
The fair fixed price is a weighted average of the future prices at each date. We use volume and a discount factor (what future cash is worth today) to weight each date.
Dates with more volume and nearer dates get more weight. Change the inputs on the right to see the result update.
What happens at settlement?
Dealer receives: Volume times Fixed price (what was agreed).
Airline receives: Volume times Market price (what the fuel actually costs).
Net to airline: The difference. If market price is above fixed, airline gains. If below, airline pays. The chart on the right shows this flow.
Curve shape: up or down?
If future prices rise over time (3 mo cheaper, 15 mo dearer), the curve slopes up — this is contango. If they fall over time, it slopes down — backwardation. The fair fixed price sits somewhere in the middle of the curve.