Hedging Strategy and Electricity Contract Engineering - IFOR

0&
K
$
0&
K
K %
+
$
2.7 Electricity contracts 25
Payoff
!
Payoff
!
0
Average spot
price in [T ,T ]
1# 2
0
Average spot
price in [T ,T ]
1# 2
Long position
Short p" osition
Fig. 2.7: Payoffs from future contracts.
Pay( off
Pay( off
%
K
F(T,T ,T' )
F(T,T ' ,T )
2
+ 1* 2
1*
Bought call
)
Bought put
)
Fig. 2.8: Payoff structure of European options.
2.7.1.3. The options market
There are two types of traded options in Europe, namely European options with
futures as underlying and Asian options with spot contracts as underlying. Both
option types are typically traded on a continuous basis. There are two types of
options, calls and puts. The buyer of a European call option is entitled, but
not obligated to buy the underlying future at the strike price K at the time
of expiration of the option T . The buyer of a European put option, on the
other hand, is entitled, but not obligated to sell the underlying future at the
strike price K . If we by , F t T 1 T 2- denote the market price at time t of the
underlying future with delivery in T 1 T 2 , where T T 1 T . 2 then the payoff
at time T of a call option is given by , F T T 1 T 2- / K and of a put option by
K , F T T 1 T / 2- , as shown in Figure 2.8, t/ where , 0 t- max . Since the
European options are typically cash settled no delivery of the underlying future
takes place and the payoff is paid in cash. The Asian options are cash settled
and the buyer of an Asian call option has a payoff at expiration T given by the
difference between the average spot price in the period T 1 T , where T 1 . T