29.1 Insurance, Weather, and Energy derivatives Chapter 29 Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.1 Insurance, Weather, and Energy Derivatives Chapter 29
292 Weather derivatives: Definitions Heating degree days(HDD): For each day this is max(0, 65- a)where A is the average of the highest and lowest temperature in°F Cooling Degree Days(CDD): For each day this is max(o, A-65 Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.2 Weather Derivatives: Definitions • Heating degree days (HDD): For each day this is max(0, 65 – A) where A is the average of the highest and lowest temperature in ºF. • Cooling Degree Days (CDD): For each day this is max(0, A – 65)
29.3 Weather derivatives: products a typical product is a forward contract or an option on the cumulative Cdd or Hdd during a month Weather derivatives are often used by energy companies to hedge the volume of energy required for heating or cooling during a particular month Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.3 Weather Derivatives: Products • A typical product is a forward contract or an option on the cumulative CDD or HDD during a month • Weather derivatives are often used by energy companies to hedge the volume of energy required for heating or cooling during a particular month
29.4 Energy Derivatives Main energy sources Oil Gas Electricity Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.4 Energy Derivatives Main energy sources: • Oil • Gas • Electricity
29.5 Oil Derivatives Virtually all derivatives available on stocks and stock indices are also available in the OTC market with oil as the underlying asset Futures and futures options traded on the New York Mercantile EXchange(NYMEX)and the International Petroleum EXchange(IPE) are also popular Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.5 Oil Derivatives • Virtually all derivatives available on stocks and stock indices are also available in the OTC market with oil as the underlying asset • Futures and futures options traded on the New York Mercantile Exchange (NYMEX) and the International Petroleum Exchange (IPE) are also popular
296 Natural gas derivatives A typical OTC contract is for the delivery of a specified amount of natural gas at a roughly uniform rate to specified location during a month NYMEX and ipe trade contracts that require delivery of 10,000 million British thermal units of natural gas to a specified location Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.6 Natural Gas Derivatives • A typical OTC contract is for the delivery of a specified amount of natural gas at a roughly uniform rate to specified location during a month. • NYMEX and IPE trade contracts that require delivery of 10,000 million British thermal units of natural gas to a specified location
29.7 Electricity Derivatives Electricity is an unusual commodity in that it cannot be stored The u. s is divided into about 140 control areas and a market for electricity is created by trading between control areas Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.7 Electricity Derivatives • Electricity is an unusual commodity in that it cannot be stored • The U.S is divided into about 140 control areas and a market for electricity is created by trading between control areas
298 Electricity Derivatives continued A typical contract allows one side to receive a specified number of megawatt hours for a specified price at a specified location during a particular month ypes of contracts 5X8,5×16,7×24, daily or monthly exercise, swIng options Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.8 Electricity Derivatives continued • A typical contract allows one side to receive a specified number of megawatt hours for a specified price at a specified location during a particular month • Types of contracts: 5x8, 5x16, 7x24, daily or monthly exercise, swing options
29.9 How an Energy Producer Hedges risks Estimate a relationship of the form Y=a+bP++E where y is the monthly profit, P is the average energy prices, T'IS temperature, and s is an error term Take a position of -b in energy forwards and -c in weather forwards Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.9 How an Energy Producer Hedges Risks • Estimate a relationship of the form Y=a+bP+cT+e where Y is the monthly profit, P is the average energy prices, T is temperature, and e is an error term • Take a position of –b in energy forwards and –c in weather forwards
29,10 Insurance derivatives cat bonds are an alternative to traditional reInsurance This is a bond issued by a subsidiary of an insurance company that pays a higher-than normal interest rate If claims of a certain type are above a certain level the interest and possibly the principal on the bond are used to meet claims Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 29.10 Insurance Derivatives • CAT bonds are an alternative to traditional reinsurance • This is a bond issued by a subsidiary of an insurance company that pays a higher-thannormal interest rate. • If claims of a certain type are above a certain level the interest and possibly the principal on the bond are used to meet claims