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Detailed Glossary
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Volume | ||
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Volume is the measure of how much of something is involved in a trade Volume = Quantity (but the term Volume is nearly always used in preference) Hence in energy trading volume may have dimensions of energy, mass, weight or volume Detail Volume is one of the important attributes of a trade Volume may be specified: As a total for the entire trade By day, month or some other period for the duration of the trade Volume has units of quantity according to the commodity: Mass (often incorrectly called weight) - often used for coal, oil and other non-gaseous commodities e.g. metric tonne (T), kilogrammes (kg) Volume - sometimes used for gaseous and liquid commodities millions cubic feet (mcf), barrels (bbl), gallons Energy - may be used for any commodity e.g. therms, Megawatt hours (MWh) For gas and electricity trades it is generally more convenient to trade in quantities of energy Other energy commodities are usually measured in volumes of mass or volume since this is more practical to measure at delivery Volume traded will directly affect the traded position of that commodity Volume may be constant over the duration of the trade, or may vary over the different delivery periods: the delivery volumes are defined in the Schedule of the trade
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Swing Contract | ||
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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 Detail 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 | ||
Spot | ||
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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) Detail 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 | ||
Speculative Trading | ||
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Speculative trading, also known as proprietary or spec. trading, is the trading of commodities with the intent of making a profit with no intent to make or take delivery of those commodities Detail Spec. traders take forward positions, either short or long with the view to closing out those positions at a later date, prior to delivery Closing out the open position involves trading to flatten the net position, eventually (but before delivery) to zero | ||
Scheduling | ||
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Often used as a term for the Operational activities involved in gas and power Detail Short term position needs to be nominated or notified to the respective system and market operators:
This set of activities is often collectively referred to as Scheduling The schedule of a trade describes the delivery profile (that will need to be nominated) | ||
Position Reporting | ||
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Traders make, and lose, money by taking positions, either short or long at various points in the future Open positions in the future imply a risk that needs to be managed very carefully as changes in the forward curves affect the value of the net open position It is therefore critical that traders know their up to date position at all times This is the purpose of Position Reporting by means of Position Reports Detail | ||
P&L | ||
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Profit and Loss (P&L) is a finance and risk reporting term to describe the profitability of an individual trade, a book, a desk, or a company. Whilst the P&L of a company includes all activity, and costs (offices, staff etc.) the trading P&L is a measure of the profitability of a single, or a set of, trade(s) Detail P&L is a change in the value of something, or a set of things between two points in time You will often hear people refer to the P&L of the trade in terms of its value - the value at any point in time is effectively the difference between the value at that point in time, and the value before the trade was executed. We usually refer to this as the Lifetime to Date P&L or LTD P&L Often we are interested in the change in value, the P&L, from the start of the year, from the start of the month, or from the last valuation. These are respectively known as:
As an example, let's say we bought some shares in a company for £60, and a year later we sold them for £100, then it seems obvious that we made £40 profit, assuming there were no cost of buying the shares, or selling them, nor indeed any other costs directly associated with the buying or selling
Before continuing we will align our example with a more normal energy trading example.
In general traders don't buy a commodity, and then sell it later because of the difficulty and cost of storing energy commodities - see Storage
In general traders enter into a Forward contract, that is to buy the shares at fixed time in the future, at a fixed price
The other advantage of Forward contracts is that the trader can enter a Forward contract to sell, as well as buy, at some time in the future. This is known as taking a short - i.e. negative - position
In March 2018 we will give £60 to the seller of the shares. This is called the financial side or leg of the trade. It has a known cash value: £60
We call this the physical side or leg (it's physical because it's not cash, even though the share certificates are electronic, we still call this physical)
In general the first method is preferred because it is simpler, we may have to use the second method when we are not sure the position is entirely closed out, or we know some is, and some isn't.
if the first method sounds odd, think about buying and selling a house, once you've bought a house you're very interested in how much you paid for it, and how much it's currently worth. Once you sell it however, you're only really interested in the price you paid and the price you sold it. You have little real interest in the current price
P&L that may result in a cash flow in the future is often discounted back to present day value
We may refer to undiscounted, and discounted P&L
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OTC | ||
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OTC - Over-The-Counter Generally used to refer to any trade not executed with an Exchange Detail Over-The-Counter trades may be executed by a broker, or directly bilaterally between two parties. The resultant trade, whether brokered or not has the following characteristics: The trade details may be anything the parties agree - compared to the standardized contracts offered on an Exchange The agreed trade price is private to the parties - although either may report it to a market data service to increase price transparency Delivery, settlement, and all credit risk is entirely between the two parties | ||
Option | ||
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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
Detail
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:
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 | ||
Nomination | ||
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An electronic message sent to a third party detailing a transaction or requirement as part of a pre-existing agreement Typically gas and power transactions are nominated to system and market operators Detail Examples of nominations:
Nominations are sent typically some time in advance, and then updated as any changes occur (new trades are executed, new forecasts are made etc.) For power and gas there are deadlines for the last nominations for a delivery period - if nominations are missed then the trading organization may face large imbalance costs so: Nominations are one of the most time-critical processes or capabilities of any trading organization In the UK nominations are officially known as Notifications - but the general term, nomination, is more usually used | ||