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.
- © 2004 Pageant Media Ltd
Don’t have access? Click here to request a demo
Alternatively, Call a member of the team to discuss membership options
US and Overseas: +1 646-931-9045
UK: 0207 139 1600