The three most fundamental risk management tools are swaps, futures, and options.

Swaps
Swaps are over-the-counter transactions between counterparties involving an exchange of cash flows. One cash flow is typically fixed while the other is floating. The floating cash flow is linked to a reference index. In the case of Commodity Swaps the reference index is the relevant futures price. Swaps are cash settled meaning that payment takes place only at maturity and is based on the difference between the fixed and floating prices.

Swap issuers are primarily banks while customers include both commodity producers and consumers. Swaps can be tailored to match customers' requirements in terms of quantity and maturity. However, early termination of swaps may involve penalties. Swaps also involve counterparty credit risk: the possibility of default by one of the parties.

Futures
Futures are exchange traded instruments that derive their value from the price of an underlying commodity. Futures contracts are standardized. They specify standard quantities and qualities of a commodity for delivery at a specific time and location(s).

They are traded on organized exchanges which are regulated by government agencies. Futures are guaranteed by the exchange clearinghouse eliminating counterparty credit risk. Futures contracts require margin deposits which represent a fraction of the notional value of the contract. The majority of contracts are cash settled although physical delivery is possible.

Options
Options represent rights but not obligations. There are two types of options. Call options represent the right to buy an underlying futures contract at a fixed strike price at any time on or before a given date. Put options represent the right to sell an underlying futures contract at a fixed strike price at any time on or before a given date.

The price of an option is determined by two factors: intrinsic value and time value. The intrinsic value of an option is based on the difference between its strike price and the price of the underlying futures contract. Time value is based on the time remaining until expiry.

The purchase of options does not require any margin deposits. Losses are limited to the price (premium) paid.

Options represent insurance against adverse price moves in the underlying commodity. The cost of the insurance is just the premium. Options are more flexible than both swaps and futures since they preserve participation in favorable price moves.