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Derivatives used in Power Markets





Derivatives with a single Underlying

Forwards and futures


A forward contract obliges each party to buy or sell a commodity at an agreed upon future date at an agreed upon strike.


Contracts for Differences (CFD) in the U.K. and Australian power markets. CFDs are financially settled.



A swap is a basket of forward contracts with multiple settlement dates.  The Fixed Price is usually the same for each settlement.

Long term supply contracts. Bilateral contracts.

Plain vanilla option

Call options: the right but not the obligation to purchase the underlying at a fixed price

Put options: the right not the obligation to sell the underlying at a fixed price

Straddle: a combination of put and call with same strike:

An option contract gives the buyer the right, (but not the obligation) to buy (call) or sell (put) the underlying at an agreed upon strike price during some predefined time period.

Capacity is equivalent to a call on the generation process (i.e. power plant, etc.). Energy is a call on the fuel--concept of converting one type of energy into another.

Callable and puttable forwards

Callable forward. Long a forward contract and short a call option.

Puttable forward. Long one forward contract and long one put option.

Interruptible Supply Contracts where the supplier can exercise the call option whenever the spot price exceeds the strike price, effectively canceling the forward contract at the time of delivery.

Dispatchable Independent Power Producer (IPP) supply contracts: The customer can exercise the put option whenever the spot price is below the strike price, effectively canceling the forward contract at the time of delivery.

Strip of calls or puts

Basket of independent options with similar characteristics but different maturities. A “cap” is a strip of Calls and a “floor” is a strip of Puts


Capacity reservation: the right to have access to capacity on a daily basis for a month translates to a strip of daily calls.

A floor ensures generators can sell at a given price in the future without being obliged to do so.

Exotic swaps

Extendible swap: Swap that contains the option to extend the swap for a given period.

Cancellable swap: a long or short swaption (option on a swap)


Enter into a one month swap transaction, but at the end of it, you have the right to extend for another month or to cancel at a particular time


Path-Dependent Options

Asian option

Average strike option: Strike is known at the time of valuing the contract

Average price option: Strike is set in the future as an average price of an underlying observed over a future period of time.

Double Asians: Strike is set at a future date (usually to the value of an index) and the payoff is based on the average of the underlying

An inflexible power plant such as that used for base-load generation can't be switched on and off in a day, but can be turned on one week and off the next. The decision to run it depends on average power price for the week.

Barrier option:
knock-in, knock-out

A contract that causes an option to come into existence (knock-in). A trigger event such as some preset price level kicks the deal into effect or terminates (knock-out) the deal.

Knock-in call: You have the right to buy power if the price falls to a preset price.

Knock-out call: You have the right to buy power at $10/MWh, but if it moves above $20/MWh then the deal falls apart. These types of options are embedded in contracts, not traded.

Digital options, binary options

Payoff is a known quantity (cash or asset), contingent on the underlying crossing (or not crossing) a particular “threshold” price.


Cash-or-Nothing, Asset-or-Nothing

Lookback options

The option holder has the right to purchase or sell the underlying asset at the best possible price attained over the life of the option.

Floating strike lookback: Generator in Australia sells option to sell power at the average of the highest 5 half-hourly prices during a particular month.


Derivatives with Multiple Underlyings

Spread option



Option on the price differential between two underlying products, locations, qualities.

Anything that converts one form of energy into another, in which one can decide when to do it. A power station is a call option on the difference between power and gas. A spark spread is an option on gas and power price. If price of power in the market is more expensive than converting gas into power, then burn your gas and sell your power.

If power is more expensive in one region than another (including transmission cost), then exercise this option.

Basis swing option

Swing option between two locations

A buyer takes a contract between two regions ­ but can change volume during the period.

Best of option

Choose the best out of a set in which all are similar in some way: type of fuels, sources, transmission criteria, etc.

You choose the cheapest of different types of fuels to convert into electricity. An aluminum producer has a best of option on its fixed price electricity contract and its workers. When power price are high, it shuts down operation and sells the power. When power prices are low, its workers produce aluminum.


Options with Variable Volume

Variable quantity options and Forwards

Fixed Price per MWh * variable amount: Variable quantity forwards with delivery price equal to the fixed price of the contract

Floating Price * variable amount: Supplier can buy spot electricity at a future date and sell it to the client at market prices. May include a maximum and/or minimum floating price.

Fixed dollar payment and variable amount

Short variable quantity forwards at zero price and Long Cash flow equivalent to the dollar amount




Basket of co-dependent American style exercise derivatives

Ruthless (maximum or minimum that maximizes profit) or non-ruthless


Non-ruthless exercise: Utility sells a contract to a large industrial end-user. Classic is the aluminum smelter plant which either uses all or nothing.

Ruthless exercise: Utility A trading with utility B in the same city in the same market.

Embedded swing option

"interruptible power"

Sale of a swap simultaneous with purchase of a swing option from the same party

Load curtailment contract: utility sells industrial users a lower priced (i.e. discounted) swap but utility gets the right to not deliver power fixed number of times in the period. This parallels what's called a "range forward" in the foreign exchange market.


Options on Options

Compound option

The option holder has the right but not the obligation to buy or sell another underlying option: a mother option and a daughter option. There can be four combinations: call on a call, call on a put, put on a call, put on a put.

Option on a call or put option: In the energy markets, it usually takes the form of an option on a strip of options, rather than on an individual put or call option.

Compound spread option

Option on an Spread Option: In the energy markets, it usually takes the form of an option on a strip of spread options.

Instead of building new power plant, a utility buys a compound option from a power marketer which gives the ability to call on a second option some time in the future. The utility thus has access to power if needed without the risks of building or owning a power plant.


Author: Anne Ku with Carlos Blanco (FEA)

This table is updated from an earlier table published in the author's article "Coping with Volatility" in Global Energy Business, Sep-Oct 2000, which also appears on web site. See table of derivatives instruments used in power market (2000)