Hedging Auction Volatility with Gap Call Options

Gilbert Mbara ()
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Gilbert Mbara: University of Warsaw, Faculty of Economic Sciences

No 2026-20, Working Papers from Faculty of Economic Sciences, University of Warsaw

Abstract: We investigate the feasibility of hedging commodity price risk using gap call options within an auction-based market devoid of traditional derivatives. Using a novel, high-frequency dataset from the Nairobi Coffee Exchange (NCE), we model spot price dynamics by deriving a Geometric Brownian Motion process from the independent private values paradigm. The estimated model captures the unique microstructure of the NCE, where discrete weekly auctions generate prices characterized by extreme volatility (146.5% annualized). We utilize Monte Carlo simulation to price and evaluate the performance of gap call options for buyers seeking protection against catastrophic price spikes. Our results demonstrate that gap options – characterized by a trigger price higher than the strike – provide superior risk-adjusted returns compared to standard European calls. Our study offers a practical framework for developing tailored risk management instruments in emerging commodity exchanges, and provides empirical evidence for the viability of gap options as a cost-effective hedging tool in high-volatility, institutionally constrained markets.

Keywords: risk management; hedging; commodity price risk; gap options; Nairobi Coffee Exchange; geometric Brownian motion; Monte Carlo simulation (search for similar items in EconPapers)
JEL-codes: G11 G13 G32 Q14 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2026
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