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Energy Options in an HJM Framework

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It is a delicate matter to trade spot products and financial derivatives in energy markets. Op-posite to bond and stock markets, the underlying assets are real products and a significant partof the demand for them represents a real need for the products, which can only be substitutedaway with some difficulties or, in some cases, only in a prohibitively costly manner. This isparticularly true in the spot market, where the demand is almost always met, but where thespot price processes can be quite different from the spot price processes conventionally used inthe pricing of derivatives. This pattern of real demand is also the main reason for the existenceof the well-known convenience yield in energy markets.

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Thomas Lyse Hansen, Bjarne Astrup Jensen

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