Commodities and Commodity Derivatives

Helyette Geman is a Professor of Finance at the University Paris Dauphine and ESSEC Graduate Business School. She is a graduate of the Ecole Normale Superieure in mathematics, holds a Masters degree in theoretical physics and a PhD in mathematics from the University Pierre et Marie Curie and a PhD in Finance from the University Pantheon Sorbonne. Professor Geman has been a scientific advisor to a number of major energy companies for the last decade, covering the spectrum of oil, natural gas and electricity as well as agricultural commodities origination and trading. She was previously the head of Research and Development at Caisse des Depots. She has published more than 40 papers in major finance journals including the Journal of Finance, Mathematical Finance, Journal of Financial Economics, Journal of Banking and Finance and Journal of Business. She has also written a book entitled Insurance and Weather Derivatives’. Professor Geman’s research includes asset price modelling using jump-diffusions and Levy processes, commodity forward curve modelling and exotic option pricing for which she won the first prize of the Merrill Lynch Awards.

"...expect to see this book become the bible of the field..." (Short Book Review, June 2006)

• Foreword by Nassim Nicholas Taleb xiPreface xvAcknowledgements xix1 Fundamentals of Commodity Spot and Futures Markets: Instruments, Exchanges and Strategies 11.1 The importance of commodity spot trading 11.2 Forward and Futures contracts 41.3 The actors in Futures markets 61.4 The structure of Futures markets 91.5 Shipping and freight: Spot and forward markets 161.6 Volume, liquidity and open interest in Futures markets 192 Equilibrium Relationships between Spot Prices and Forward Prices 232.1 Price discovery in Futures markets 232.2 Theory of storage, inventory and convenience yield 242.3 Scarcity, reserves and price volatility 282.4 Futures prices and expectations of future spot prices 312.5 Spot–forward relationship in commodity markets under no-arbitrage 352.6 Price of a Futures contract and market value of a Futures position 392.7 Relationship between forward and Futures prices 422.8 The benefits of indexes in commodity markets 453 Stochastic Modeling of Commodity Price Processes 493.1 Randomness and commodity prices 493.2 The distribution of commodity prices and their first four moments 523.3 The geometric Brownian motion as a central model in finance 603.4 Mean-reversion in financial modeling: From interest rates to commodities 643.5 Introducing stochastic volatility and jumps in price trajectories 683.6 State variable models for commodity prices 693.7 Commodity forward curve dynamics 714 Plain-vanilla Option Pricing and Hedging: From Stocks to Commodities 754.1 General definitions 754.2 Classical strategies involving European calls and puts 784.3 Put–call parity 814.4 Valuation of European calls: The Black–Scholes formula and the Greeks 834.5 Merton (1973) formula and its application to options on commodity spot prices 904.6 Options on commodity spot prices 924.7 Options on commodity Futures and the Black (1976) formula 935 Risk-neutral Valuation of Plain-vanilla Options 955.1 Second proof of the Black–Scholes–Merton formula 955.2 Risk-neutral dynamics of commodity prices 985.3 Commodity Futures dynamics under the pricing measure 995.4 Implied volatility in equity options and leverage effect 1015.5 Implied volatility in energy option prices and inverse leverage effect 1055.6 Binomial trees and option pricing 1095.7 Introducing stochastic interest rates in the valuation of commodity options 1176 Monte Carlo Simulations and Analytical Formulae for Asian, Barrier and Quanto Options 1236.1 Monte Carlo methods for European options 1236.2 Asian (arithmetic average) options as key instruments in commodity markets 1276.3 Trading the shape of the forward curve through floating strike Asian options 1356.4 Barrier options 1356.5 Commodity quanto options 1387 Agricultural Commodity Markets 1437.1 Introduction 1437.2 The grain markets 1447.3 Soft commodities: Coffee, cotton and sugar 1537.4 Citrus and orange juice 1587.5 Livestock markets 1607.6 Technical analysis in agricultural commodity markets 1618 The Structure of Metal Markets and Metal Prices 1698.1 Introduction 1698.2 About metals 1698.3 Overview of metal markets and their operation 1718.4 Characterizing general price movements 1758.5 Characterizing metal price movements 1768.6 Conclusion 2009 The Oil Market as a World Market 2019.1 Why oil is traded and its relationship with worldwide energy prices 2019.2 Crude oil markets 2039.3 Refined products markets 2179.4 Conclusion 22410 The Gas Market as the Energy Market of the Next Decades 22710.1 The world gas outlook 22710.2 The gas-producing countries 23110.3 Gas spot markets 23310.4 Natural gas Futures and options 24010.5 The growing interest in LNG 24611 Spot and Forward Electricity Markets 25111.1 Introduction 25111.2 Structure of the electricity industry: From vertically integrated utilities to unbundling and restructured oligopolies 25211.3 Spot power markets and issues in market design 25411.4 The adjustment market and reserves capacity 26611.5 Electricity derivatives markets 26911.6 Modeling electricity spot prices: From mean-reversion and jump-diffusion to jump-reversion 27612 Commodity Swaptions, Swing Contracts and Real Options in the Energy Industry 28312.1 Commodity swap and swaptions 28312.2 Exchange options 28612.3 Commodity spread options 28712.4 Options involving optimal strategies: American, swing and take-or-pay contracts 29412.5 Discounted cash flows versus real options for the valuation of physical assets: The example of a fuel-fired plant 29812.6 Valuation of a gas storage facility 30413 Coal, Emissions and Weather 30913.1 The coal market 30913.2 Emissions 32013.3 Weather and commodity markets 32514 Commodities as a New Asset Class 33314.1 Introduction 33314.2 The different ways of investing in commodities 33614.3 Commodity indexes and commodity-related funds 33914.4 Conclusion 357Appendix: Glossary 359References 375Index 381