Practical Valuation of Power Derivatives

Espen Haug takes a traders perspective on the valuation of power derivatives. Get your Margaritas ready.

In this paper I look at the practical valuation of power derivatives from a trader’s perspective. Most people that have written about valuation of power derivatives are academics or quants working in the research departments of large organizations far away from the trading desk. Most of them have never traded a single power option. In general there is nothing wrong with that as some of
the greatest practical research in quantitative finance has come out of academia and research departments, we just have to mention the Black-Scholes-Merton model to remind us of that. This also brings to mind some big swinging traders who have told me that they don’t care about the theory, and the very next second were looking at the Black-Scholes-Merton delta on their Bloomberg screen to hedge some options. Anyway, when it comes to electricity derivatives most academics have made simple things too complex and at the same time have forgotten simple things that have great importance. The Black-Scholes-Merton model or its binomial equivalent is a great example of making things simple enough, but not simpler than that, at least when it comes to equity, futures or currency options. Still, as we will see the Black-Scholes-Merton model, or rather the formula will not necessarily do without some modifications when applied to the electricity market. This article was written during a research sabbatical from trading, to be honest most of this article was written from a bar in the town of Trondheim, one of the greatest university towns on this planet. To write or read about formulas and abstract mathematics is in my experience best done in a relaxing atmosphere. A frozen margarita could certainly help you absorb this article once you have finished reading it, or better still before.

Logged-in members can download the article by clicking the link below. To log in or register visit here.

Related Posts

Calibration problems – An inverse problems v... When pricing structured or derivative financial instruments, the typical steps a quant has to do are the following: 1. Choose a model for the m...
What is Implied by Implied Volatility? Word and concept Implied volatility is not just a word or a concept. As a word, what is implied by implied volatility – what “implied volatili...
Big Time Series Analysis with JuliaDB The next generation of data analysis requires the next generation of tools. The most popular opensource packages for data analysis (Python’s pandas an...
Introduction to Variance Swaps The purpose of this article is to introduce the properties of variance swaps, and give insights into the hedging and valuation of these instrument...
Monte Carlo in Esperanto This article shows how a simple parser environment in Excel/VBA could be used to perform single and multi-dimensional Monte Carlo. The clsMathParser i...
Numerical Methods for the Markov Functional Model The Libor Market Model of Brace Gatarek and Musiela (BGM) (1997) is the market standard model for pricing and hedging exotic interest rate derivat...
A Generalised Procedure for Locating the Optimal C... The fundamental concepts that shape modern capital structuring theory were first put together by Modigliani and Miller (1958) in a series of proposit...
The Great Investors, Their Methods and How We Eval... Winning has two parts: getting an edge and then betting well. The former simply means that investments have an advantage so $1 invested returns on...
111102_collector