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Monthly heat rate call options
Posted: March 26th, 2009, 8:43 pm
by jcchen
Two questions.1) Say to price a monthly ERCOT 10 heat rate call option. I treat it as a basket of 30 European spread calls. I price the option value for the middle of the month using Kirk's Approximation, then multiply it by 30 to get the monthly premium. Is this an acceptible method for a rough picture?2) How to hedge such heat rate call option with standard forwards or balance of the month contracts?Thanks a lot!JCC
Monthly heat rate call options
Posted: April 22nd, 2009, 5:02 pm
by nparaschos
why are you pricing it a series or basket of 30 spread calls if it's a monthly option? Why not price it as monthly spread option with monthly forward prices for power and gas?
Monthly heat rate call options
Posted: April 24th, 2009, 4:57 pm
by Beachcomber
If you are talking about a daily exercised monthly option, generally you use a daily volatility in the formula. You also need to consider a daily correlation. I believe that most brokerages quote both monthly and daily volatilities.For hedging, you just delta hedge the natural gas and electricity legs. I think that Rene Carmona and Valdo Durrleman wrote a pretty good article on the pricing and hedging of spread options as they apply to energy.