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Swing Option and Take-or-Pay Contracts
The characteristics of these contracts are . . .
- the maximum number of units that can be delivered (exercised) per hour or per day is constrained
- a minimum number of units must be delivered (exercised) over the whole contract term
- the number of exercises allowed is less than or equal to the number of days over the whole contract term and
- the strike may be either fixed or some first-of-month index
Some contracts even allow the number of delivered units on any exercise to be a
choice variable.
WTM Energy Software, LLC, has developed the backward recursion methodology
to accurately value these contracts using tree models. Coupling this recursion methodology with WTM’s
proprietary two-factor tree allows for accurate valuations and hedging of these contracts. Ask us about it!
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