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Primary Article

Pricing of Electricity Swing Options

Jussi Keppo
The Journal of Derivatives Spring 2004, 11 (3) 26-43; DOI: https://doi.org/10.3905/jod.2004.391033
Jussi Keppo
An assistant professor of industrial and operations engineering at the University of Michigan, in Ann Arbor, MI.
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Abstract

Electricity is one of the most important commodities for both consumers and producers, and it is subject to sharp variations in supply and demand, sometimes within a single day. But it is also one of the most difficult commodities on which to trade derivatives, because electricity is virtually unstorable. This has given rise to contracts such as the “swing option,” which sets minimum and maximum values for both the amount of power to be purchased in each period and also the cumulative amount of electricity purchased over the life of the contract. A swing option thus entails complex timing options with regard to fulfillment of the required minimum cumulative quantity purchased, and price-related options that let the holder buy more when the market price is above the option's strike price, all constrained by the limits on maximum instantaneous and cumulative consumption. In this article, Keppo describes the decision process and presents a swing option valuation model based on simple electricity forwards and options. The use of the approach is illustrated with a couple of examples based on Nord Pool electricity prices.

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The Journal of Derivatives
Vol. 11, Issue 3
Spring 2004
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Pricing of Electricity Swing Options
Jussi Keppo
The Journal of Derivatives Feb 2004, 11 (3) 26-43; DOI: 10.3905/jod.2004.391033

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Pricing of Electricity Swing Options
Jussi Keppo
The Journal of Derivatives Feb 2004, 11 (3) 26-43; DOI: 10.3905/jod.2004.391033
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