Swinging on a Tree（457-467）.pdfVIP

20 Swinging on a Tree* Key words: interruptible contracts, energy prices, dynamic programming A swing contract grants the holder a number of transaction rights on a given asset for a fixed strike price. Each right consists of the double option to select timing and quantity to be delivered under certain limitations. Transactions are specified by the contract structure and usually involve a supplementary right to choose between purchase and selling. Swing contracts are very popular in markets where delivery is linked to consumption or usage over time. This is the case of energy commodity markets such as oil, gas and electricity. There, swing features are usually embodied in a base-load contract providing a constant flow of the commodity for a fixed tariff. A typical scheme involves a retailer selling gas to a final consumer. The contract contains an option to interrupt delivery for a predetermined number of times. From a financial viewpoint, the retailer is short one strip of forward contracts, one con- tract per delivery day, and long one swing option allowing for adjustments in the gas delivery according to contingent market conditions. The joint position is often re- ferred to as a callable forward contract. Beyond side commitments existing between the two counterparts, the swing option exercise policy depends on standing market conditions such as the commodity spot price and availability. The net cash flow for the retailer is given by the forward price received upon delivery minus the option premium paid to the consumer and usually settled as a discount premium over the forward price; plus any cash flow stemming from exercising the option. The purpose of this chapter is to evaluate a swing option with non-trivial con- straints by means of dynamic programming. General treatments on swing contracts are discussed by Clewlow and Strickland (2000) and Eydeland and Wolyniec (2002). The seminal paper by Thompson (1995) tackles the