Derivatives Flashcards
What is a energy derivative
contract derived from an underlying energy related commodity.
> It could be physical: an agreement to trade a commodity
at some future date
>Or financial: an exchange of cash flows based on energy prices at future dates
How can derivatives be splitter?
without optionality: forward, futures & swaps
with different sorts of optionality: options on standard forward/futures or on non-standards (e.g., hourly options, swings, power plant)
What is the keys interest here?
to find the fair value of a derivative (i.e., the price a neutral market participant would be willing to pay
Marked-to-market valuation
daily assessment of the market prices prices of a derivative, when the derivative liquid.
Describe Forward contracts
- > Bilateral agreement to sell/buy a certain amount of a commodity on a fixed delivery date. Both a parties are obliged to deliver & pay.
- > Products: standards and non standards
- > Payment: occurs at a date close after delivery. (no cf until delivery)
- > Deal closure: broker or electronic platform
- > Challenge: credit risk ( one party does not full his obligation to deliver or pay
->Standards of the contracts: EFET-
invoicing: no later than the 10th day of the month following delivery
payment: no later than the 20th day of the month following delivery
- Formula
Today’s forward value = (current market price of a forward at time t for a given delivery T - price at which the contract was concluded) * e ^ -interest rate* (T-t)
-> Sentivity to changes in the underlying’s value: AV= AF*e^-r(T-t)
Describe Futures contracts
- > often settled only financially. sometimes they allow to choose btw physical or financial settlement (before maturity)
- > Deal Closure: commodity exchange trading system, there is also a clearing house that eliminates the credit risk included in OTC contracts
- > Products: standards
->Challenges: Clearing houses demand payment of margins( initial and variation)
>initial-entry ticket;
>daily - day by day marking to market, reduces or increases the balance of margin account subject to delay fluctuation on price;
>maintenance - min. level of balance of margin account must fall below maintenance margin level
->Daily realisation of profits and loses leads to particular cash liquidity requirements compared to forward contracts.
-> Sentivity to changes in the underlying’s value AF:
AV= AF
Describe how the margin account in the future contract work?
Maint and initial margins are given
- Se empieza con un margin inicial de x en t=0
- Se suma o resta el delta P&L de del t=1 al initial margin
- Repetir suma o resta. En caso de que el margin account tenga un valor menor al del maint. margin, se anade el inicial margin nuevamente.Si la cantidad es menor a 0 (e.g. - 62.80. se anade esa cantidad mas el intial margin (i.e., 262.80)
Describe Swap Contracts
- > One couterpart (customer) pays the other counterpart (trader) a fixed payment at a pre-determined date, whereas the other counterpart (trader) pays at the same day varible payments. IOW: at settlement both parties exchange the difference between fixed and floating price. On the other hand, customer needs to buy power form the market, thus gets electricity from the market at a spot price.
- > Settled only financial
Describe the Future and Forward Option contract
->Both have the obligation to buy or sell a defined amount of energy within a defined time period in the future at an agreed price. Both, buyer and seller are securing prices for future energy delivery.
- > buyer will profit form rising energy prices and the seller the other way around.
- > product with a fixed price and symmetric risk profile (what one side gains the other side loses)
Describe the call option
Rights and Obligations:
- buyer of a call has the right but not the obligation to buy a a def. quantity at a agreed price by paying an option premium. (Piensa que precios pueden subir)
- seller must sell in case buyer want to excecute the option
Profits and risks:
- buyer is protected against higher energy prices, but may still profit from lower energy prices.
- seller receives an option premium but may face infinite losses.
Describe a put option
gives the holder of the the option to sell a defined quantity of a commodity to the option seller.
What are the key option parameters
time to maturity (time gap) strike price ( can be ITM, ATM, OTM)
Mention and explain two hedging strategies
- Covered call (short call and forward) - expect prices to increase a bit
- Protective put (forward and long put)
importan consequence of a put-call parity
the value of a call option can be calculated by the corresponding put option and the corresponding forward and vice versa.
what are the relevant elements considering for valuing an option
Time value: time gap between today and the time to maturity (long or short?) (also value coming from the future price developments of the underlying. => function of time to maturity and volatility of the underlying
Intrinsic or inner value: value if the option is to be exercised now => function of the strike price and current market price of the corresponding underlying. (assessment of the option to the current prices=
