Spread options have a payoff determined by the difference between the prices of two assets and a fixed strike price. These options are often used in commodity markets to hedge the spread between two different underlyings such as WTI vs BRENT oil contracts, can be known as Crack Spread options if there were on Oil vs a derived product such as Heating Oil.
Similarly, for power generators they may use Spark Spread Options to price options that are based on the the various inputs that can be used to create electrictity.
Spread Option Payoff
Where;
S1 = Asset 1
S2 = Asset 2
X = Strike
Spread option valuation
Resolution uses the Kirk (1995) approach to value Spread options. If you'd like to try the Spread Option Calculator in ResolutionPro, click here.


where


The volatility of can be approximated by


where

c = Price of European call
p = Price of European put
F_{1 }= Price on futures contract one
F_{2} = Price on futures contract two
X = Strike price
T = Time to maturity
r = risk free rate
= Volatility of future one
= Volatility of future two
= Correlation between the two contracts
N = The cumulative normal distribution function

For more information see our pricing plans.



Free Trial 

ResolutionPro is a derivative pricing library which supports the valuation, risk management and hedge accounting of derivatives & other financial instruments.
You can try ResolutionPro right now on a free trial basis.
 


Most Popular Posts 
 Interest Rate Swap Tutorial, Part 5 of 5, building your swap curve
 Interest Rate Swap Tutorial, Part 4 of 5, swap curve construction
 Interest Rate Swap Tutorial, Part 3 of 5, Floating Legs
 Interest Rate Swap Tutorial, Part 1 of 5, terminology
 Interest Rate Swap Tutorial, Part 2 of 5, Fixed Legs
 Business day conventions used for interest rate swaps & other derivatives
 Building a swap curve
 Currency options pricing explained
 Finding swap rates
 Black Scholes equity example

