Valuation of commodity-based swing options

Rudiger Kiesel, Jochen Gernhard and Sven-Olaf Stoll

Journal of Energy Markets

Abstract: ABSTRACT It is often necessary to structure time-varying demand for energy sources such as electricity or fuel coming from, on the one hand, seasonal variations and, on the other hand, from unexpected variations in production. This results in the need for some structural flexibility in delivery contracts of the energy sources. A special type of option was therefore introduced: the so-called swing option.We consider the valuation of a type of swing option with a recovery time which is widely used on the oil market.We develop a least-squares Monte Carlo approach suitable for such swing options with recovery time, whereby we allow different recovery-time constraints. Using a standard model for the oil price, we present some numerical results and compare the performance of the least-squares Monte Carlo approach with a finite-difference approach.

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