Detailed Glossary

A Detailed Glossary of Energy Trading terms for registered users

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Linear trade

by Nick Henfrey - Thursday, 4 September 2014, 4:42 PM

A trade with no optionality



The linearity refers to the delta - that is the variation of the value of the trade with the main underlier

Trades with no optionality have a value that is directly proportional to the value of the underlier - if we plot the value against the value of the underlier it will be a straight line - hence linear trade

Trades with optionality do not have a linear relationship between value and underlier. As the value of the underlier becomes less and less favourable the value of the trade becomes nearer and nearer to zero

Unsurprisingly these trades are known as non-linear



by Nick Henfrey - Monday, 13 April 2015, 5:42 PM
At its simplest an energy option is an instrument that gives the buyer the right, but not the obligation, to buy, or to sell, a commodity at a specified price at some point in the future.
More complex options may be financially settled, the payout being dependent on some condition(s) being met, and varying with some observable value(s) at the time of exercise
There is usually a single non-refundable payment made by the buyer of the option (the holder) to the seller of the option (the writer) - this is the option premium
First, let's try and categorize the different types of options we'll come across, and then describe each in detail, starting with the simplest:
1. Vanilla options - so called because they are a standard "flavour", which may themselves be divided into:
a) Simple physical options - already briefly described above, these include European and American options
b) Financially settled options - these pay out if some measurable, usually a published index, meets some specified criteria. The payout varies with this or other measurables. This category includes Asian options
c) Simple combination options - not strictly different types of options, but traders frequently combine simple options to tailor risk and payout to their circumstances
2. Exotic options - in contrast to vanilla options, exotic options are non-standard, usually complex and are designed to offer, or conceal, a combination of characteristics
Let's look at the simpler types in more detail
Simple physical options
Simple physical options may be thought of as an option to execute a Forward Contract. Indeed, if the option is exercised it effectively becomes a Forward Contract
When the option is traded the following terms are agreed:
  • Whether the option buyer has the right to sell the commodity or buy it - that is whether the Forward would be a buy or sell:
    • An option to buy is a call option
    • An option to sell is a put option 
  • The price that the commodity will be bought or sold at - the strike price of the Forward Contract
  • The type of the option - which determines the exercise time or period, that is when the buyer of the option may exercise their right
    • A European option may be exercised at a specific date, specified at time of execution
    • An American option may be exercised at any time in a date range, specified at time of execution
  • It also follows that the Option terms must include all terms of the potential Forward Contract, that is delivery location, volume and timing

Financial options

Financial options pay out a cash amount if they are in the money - the cash payout usually being the difference between a fixed strike price, and some variable observable, usually the published price of a energy commodity or product

Spread options and options on swaps (swaptions) are types of financial options

Asian options are financial options which pay out on the average price of an underlier over the delivery period - assuming they are in the money



by Nick Henfrey - Monday, 13 April 2015, 6:01 PM

A spot trade in general refers to a trade with immediate delivery. In energy trading terms it usually refers to a trade with delivery on the day it is executed (within day) or for the following day (day ahead)


There is usually high volume trading in spots, particularly for power and gas, as speculative traders try and close out their positions as delivery times approach, and asset-backed traders try to balance, and financially optimize their positions. A large proportion of spots are traded on Exchanges and through Brokers

Spot trades are settled physically, and even if executed on an Exchange are often settled by invoice and payment within a day or two of delivery



by Nick Henfrey - Wednesday, 3 September 2014, 5:20 PM

A spread is a difference in price, or value, of two similar but different underliers

An Energy Spread trade s a type of trade between two floating prices on similar but not identical energy underliers


Spread trades are usually financially settled

Different types of Energy Spread are classified by the difference in the underliers:

Many commodity spreads are associated with the cost of generating electricity, so they involve electricity as one commodity, the others may be:

  • Gas - usually called a Spark Spread
  • Coal - usually called a Dark Spread
  • Oil - usually called a Slick Spread 

Another group of commodity spreads are associated with the cost of refining, so they involve crude oil as one commodity, the others being refined products such as gasoline. These are known as crack spreads

Spread is also used to describe the difference in prices between locations, times, commodities


Picture of System Administrator


by System Administrator - Wednesday, 3 September 2014, 7:30 AM

An Energy Swap is generally a swap of two different prices on an identical, or similar, Energy underlier


While financial market swaps may involve swapping almost any cash flow for any other cash flow, an Energy Swap involves the swap of two different prices on an identical, or similar energy product or underlier.

The two types of Energy Swap are:

  • Fixed for Floating - one price is fixed by agreement in the trade terms, the other price is derived from one or more published indices based on a formula agreed in the trade terms
  • Floating for floating - both prices are derived from one or more published indices based on a formula agreed in the trade terms. This type of Swap is also known as a Basis Swap

By definition, Energy Swaps are always financially settled

Energy swaps may be traded OTC or on an Exchange

An Energy Swap is very similar to a a financially settled Futures or Forward Contract

Exchange traded swaps are generally settled through non-daily margining - and therefore have credit risk

Financially settled futures, like all futures, are settled through daily margining - and have minimal credit risk


Swing Contract

by Nick Henfrey - Monday, 13 April 2015, 6:04 PM

Also known as a swing option, a swing contract is a type of contract that allows the buyer the option, but not the obligation, to take periodic deliveries of a product at a volume nominated by them between a minimum and a maximum volume at an agreed price


Swing contracts ate typically used in long term supply contracts of gas, oil and power

They are frequently combined with a take or pay clause, which specifies that a minimum amount of product must be taken over a set of long periods

e.g. A swing contract may specify that a daily volume between 10 and 100 units may be taken each day

A take or pay clause may specify that a minimum of 365 * 15 units may be taken over the entire year

Daily nominations of swing contracts are usually made by a particular time on the previous day, and may be transmitted electronically

Valuation of swing contracts is extremely complex, because of the daily optionality, and particularly if there is a take or pay clause as the overall delivery is constrained

Swing contracts may be short or long term (up to twenty-five years). Typically the price is either renegotiated periodically, or indexed to an index, or a basket of indexes 


Take or Pay

by Nick Henfrey - Sunday, 12 April 2015, 3:34 PM

A type of supply contract in which the buyer commits to buying a minimum quantity of some product, or to make an alternative payment for the amount below the minimum quantity

Take or Pay contracts are widely used in the Gas and Oil markets


The minimum quantity, the price of purchase, and the price paid for any amount below the minimum are all defined in the contract

Typically the buyer nominates a delivery volume each day from the supplier, the minimum quantity applies over a year


Tolling Agreement

by Nick Henfrey - Wednesday, 12 November 2014, 5:28 PM

A general term used to describe an agreement in which one party (the toller) provides an input product to the other party, and the other party provides another product (usually derived from the input product) in return


In the energy sector tolling agreements may cover:

  • refining - crude oil for a refined product
  • gasification - natural gas for LNG
  • power generation - source fuel, usually natural gas, (and maybe carbon certificates) for power

In effect a tolling agreement is a physically implemented spread



by Nick Henfrey - Monday, 8 June 2015, 7:37 AM

Something physical or tangible that may be referenced by a contract or trade


Financial derivatives are completely cash-based and usually have no physical underliers

Energy derivatives usually have at least one physical underlier, which may be a commodity,

e.g. coal

or a something related to a commodity

e.g. storage

The underlier acts as a bridge to the physical world - and usually as a set of reference prices for price-setting and valuation

We need to emphasize that nearly all energy trades have at least one physical underlier - few of them actually involve the delivery of energy commodities





by Nick Henfrey - Wednesday, 15 April 2015, 7:31 AM

The difference in cost of achieving the same outcome through different means


This is easiest explained as an example:

To buy a particular new car in the UK costs £27,000

The identical UK-spec car costs £22,000 in Belgium

It will cost you about £1,000 to have it shipped to the UK, plus another £1,000 costs for delivery, any inspections, your time to manage all this etc.

Cost of buying the car in the UK = £27,000

Total cost of buying the car in Belgium and having it delivered to your home = £24,000

There is an arbitrage opportunity of £3,000

In general, in a liquid market, with minimal market constraints, traders will exploit any arbitrage, and the arbitrage values should all tend to zero

In our example if everyone chose to buy the car in Belgium:

the price would probably go up in Belgium because of the higher demand

the cost of shipping might go up (because of demand and the realization it's valuable)

the price of the car in the UK would probably fall (because they weren't selling any)

When the market acts to reduce arbitrage to insignificant values then we describe this as arbitrage-free

Arbitrage-free is a powerful method in many valuation tools: it implies we can value an Instrument or trade by looking at alternative ways of achieving the same outcome

For example the value of an oil forward contract in six months time, should not be significantly different to the spot price of oil, plus all of the costs of storing that oil for six months

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