Pricing and Hedging Options in Energy Markets Using Black-76

36 Pages Posted: 6 Jun 2016

Date Written: June 30, 2014

Abstract

We prove that the prices of options on forwards in commodity markets converge to the Black-76 formula when the short-term variations of the logarithmic spot price are a stationary Ornstein–Uhlenbeck process and the long-term variations are following a drifted Brownian motion. The convergence rate is exponential in the speed of mean reversion and time to delivery of the underlying forward from the exercise time of the option. This can be applied to energy markets like electricity and gas to argue for the use of Black-76 in pricing of options, although the spot prices may show large spikes. Furthermore, we prove that the quadratic hedging strategy converges in a similar fashion to the delta-hedge in the Black-76 model. Our results are illustrated with a numerical example of relevance to energy markets.

Keywords: energy markets, pricing, hedging, Black-76 model

Suggested Citation

Benth, Fred Espen and Schmeck, Maren, Pricing and Hedging Options in Energy Markets Using Black-76 (June 30, 2014). Journal of Energy Markets, Vol. 7, No. 2, 2014, Available at SSRN: https://ssrn.com/abstract=2789607

Fred Espen Benth (Contact Author)

University of Oslo ( email )

Center of Mathematics for Applications
Oslo, N-0317
Norway

Maren Schmeck

University of Oslo ( email )

PO Box 6706 St Olavs plass
Oslo, N-0317
Norway

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
0
Abstract Views
510
PlumX Metrics