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15 Jun 08
Author: John Breslin, Les Clewlow, Chris Strickland, Calvin Kwok, Matthias Pfau
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Spread options are used in many markets for trading and risk management. One of the main trading activities in energy markets is trading the differences between individual commodities.
Despite the importance and widespread use of calendar, locational, crack and spark spreads, there does not exist a consistent framework for pricing and hedging general spread options in a modelling framework that is relevant for energy prices.
If enough data is available, then using a general MFMC model for the price dynamics allows us to account for a very rich set of modelling assumptions. In this article we describe how the MFMC model can be used as the basis of a Monte Carlo simulation for the valuation of complicated spread options that depend on a basket of energy prices.
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