Pricing and Hedging Quanto Options in Energy Markets

Posted: 22 Aug 2012 Last revised: 10 Jun 2016

See all articles by Fred Espen Benth

Fred Espen Benth

University of Oslo

Nina Lange

Copenhagen Business School

Tor Age Myklebust

Norwegian School of Economics (NHH)

Date Written: January 31, 2014

Abstract

In energy markets, the use of quanto options have increased significantly in the recent years. The payoff from such options are typically written on an underlying energy index and a measure of temperature and are suited for managing the joint price and volume risk in energy markets. Using an HJM approach we derive a closed form option pricing formula for energy quanto options, under the assumption that the underlying assets are log-normally distributed. Our approach encompasses several interesting cases, such as geometric Brownian motions and multifactor spot models. We also derive delta and gamma expressions for hedging. Furthermore, we illustrate the use of our model by an empirical pricing exercise using NYMEX traded natural gas futures and CME traded Heating Degree Days futures for New York.

Keywords: gas markets, quanto options, HDD futures, temperature, energy, derivatives pricing, weather derivatives

JEL Classification: G13

Suggested Citation

Benth, Fred Espen and Lange, Nina and Myklebust, Tor Age, Pricing and Hedging Quanto Options in Energy Markets (January 31, 2014). Journal of Energy Markets, 2015, Available at SSRN: https://ssrn.com/abstract=2133935 or http://dx.doi.org/10.2139/ssrn.2133935

Fred Espen Benth

University of Oslo ( email )

Center of Mathematics for Applications
Oslo, N-0317
Norway

Nina Lange (Contact Author)

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Tor Age Myklebust

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

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