Valuation of commodity-based swing options. (English) Zbl 1232.90340

Jaillet, Patrick; Ronn, Ehud I.; Tompaidis, Stathis

Manage. Sci. 50, No. 7, 909-921 (2004).

Summary: In the energy markets, in particular the electricity and natural gas markets, many contracts incorporate flexibility-of-delivery options known as “swing” or “take-or-pay” options. Subject to daily as well as periodic constraints, these contracts permit the option holder to repeatedly exercise the right to receive greater or smaller amounts of energy. We extract market information from forward prices and volatilities and build a pricing framework for swing options based on a one-factor mean-reverting stochastic process for energy prices that explicitly incorporates seasonal effects. We present a numerical scheme for the valuation of swing options calibrated for the case of natural gas.

MSC:

90C39	Dynamic programming
91G20	Derivative securities (option pricing, hedging, etc.)

Keywords:

energy prices; seasonality; one-factor model; numerical valuations; dynamic programming; binomial forest