Affiliations: Exelon Corporation, Kennett Square, PA, USA. E-mail: [email protected] | INSEAD, The Wharton School of the University of Pensylvania, Philadelphia, PA, USA. E-mail: [email protected]
Note:  Corresponding author.
Abstract: Spark spread options are important in today's electricity markets. Such options come in various forms, including financial contracts, tolling agreements and owned generation units. In this paper, we introduce “two-leg” Delta hedging of spark spread options and analyze the conditions under which such two-leg Delta hedging is accurate. We also extend this to “Delta–Gamma” hedging, and analyze the differences between the two. Finally, we discuss the implications of such spark spread options for strategies to manage an overall electricity supply portfolio with assets and hedging instruments defined on a spot month.