Classic cutting edge: Swing options and the quest for valuation

Energy Risk presents a classic paper on swing options pricing by Patrick Jaillet, Ehud Ronn and Stathis Tompaidis, which was first published in 1998. It introduced the so-called binomial forest method, which was influential in the development of pricing methods for path-dependent options. While today’s swing contracts are valued with more modern techniques, binomial trees and binomial forests remain in use for natural gas storage valuation

In the energy world – in particular natural gas and electricity – many contracts incorporate flexibility-of-delivery options. Subject to daily as well as periodic (monthly, or semi-annual) constraints, they permit the option holder to exercise the right repeatedly to receive greater or smaller amounts of energy. Consequently, these options have an implicit dependence through time: the exercise of an option today limits, and may eliminate, the ability to draw such energy tomorrow. These options