The valuation of optional financial contract in electricity market

In the power and energy market, financial contracts with optionality are often used to accommodate the natural variations in energy consumption or production, and provide cost-free solutions to energy storage. This paper presents a study exploring the valuation of swing option, a typical optional financial contract, which has multiple exercise rights and gives the option holder much flexibility in execution. We analyze the stochastic properties of the underlying price process - electricity price forecast error, then construct a binomial tree based framework to estimate the maximized swing option expected payoff and find the optimal exercise decisions.