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Valuing Energy Options in a One Factor Model Fitted to Forward Prices

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  • Les Clewlow

    (Lacima Group)

  • Chris Strickland

    (Lacima Group)

Abstract

In this paper we develop a single-factor modeling framework which is consistent with market observable forward prices and volatilities. The model is a special case of the multi-factor model developed in Clewlow and Stickland [1999b] and leads to analytical pricing formula for standard options, caps, floors, collars and swaptions. We also show how American style and exotic energy derivatives can be priced using trinomial trees, which are constructed to be consistent with the forward curve and volatility structure. We demonstrate the application of the trinomial tree to the pricing of a European and American Asian option. The analysis in this paper extends the results in Schwartz [1997] and Amin, et al. [1995].

Suggested Citation

  • Les Clewlow & Chris Strickland, 1999. "Valuing Energy Options in a One Factor Model Fitted to Forward Prices," Research Paper Series 10, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:10
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    File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp10.pdf
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    References listed on IDEAS

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    1. Kaushik I. Amin & Robert A. Jarrow, 2008. "Pricing Options On Risky Assets In A Stochastic Interest Rate Economy," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 15, pages 327-347 World Scientific Publishing Co. Pte. Ltd..
    2. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
    3. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305 World Scientific Publishing Co. Pte. Ltd..
    4. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
    5. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, vol. 45(3), pages 959-976, July.
    6. Kaushik I. Amin & Robert A. Jarrow, 2008. "Pricing foreign currency options under stochastic interest rates," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 14, pages 307-326 World Scientific Publishing Co. Pte. Ltd..
    7. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    8. Cox, John C. & Ingersoll, Jonathan Jr. & Ross, Stephen A., 1981. "The relation between forward prices and futures prices," Journal of Financial Economics, Elsevier, vol. 9(4), pages 321-346, December.
    9. Hilliard, Jimmy E. & Reis, Jorge, 1998. "Valuation of Commodity Futures and Options under Stochastic Convenience Yields, Interest Rates, and Jump Diffusions in the Spot," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(01), pages 61-86, March.
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