Average Pricing Swap

An Average Pricing Swap is a derivative in which the settlement value is determined by the arithmetic average of a specified index price observed over a defined period—such as daily assessments across a month—rather than a single final settlement price. In energy markets, these instruments are widely used to hedge exposure to monthly index-linked physical contracts, manage pricing uncertainty across volatile periods, and smooth the impact of short-term price spikes or disruptions. For example, crude oil cargos, natural gas contracts, refined-product deliveries, and LNG offtake agreements frequently settle against monthly average indices published by Price Reporting Agencies or exchanges. An Average Pricing Swap allows a trader to lock in a forward average price that mirrors the structure of these physical cash flows. Because daily prices can fluctuate sharply due to weather, geopolitical events, outages, pipeline constraints, or macroeconomic news, averaging reduces the influence of any single extreme observation. Average Pricing Swaps also play a role in volatility management. Their valuation incorporates not only forward prices but the expected distribution of daily prices over the averaging window. Traders may use them to hedge basis risk, align financial hedges with physical exposures, or express structured market views around expected price paths.