transport model

Andy,

The scale effect in the transport model can be explained.

I use a European option to do the illustration.

I raise the underlying and strike price by the same amount, use the fuel
percentage to adjust the strike.
The net result is the intrinsic value decreases as the level goes up.

If the fuel percentage is not very high, the option premium actually
increases with the level, although the
intrinsic value decreases.

If the fuel percentage is very high (<8%), then we see a decreasing option
price.

In the transport deal, fuel change is often below 5%, so you will not see a
decreasing spread option price
when NYMEX moves up. So I think the transport model still does what it
should do.

Zimin

In the following exmaple, I used r=6%, vol=20%, T=100days, see spreadsheet
for details.

---------------------- Forwarded by Zimin Lu/HOU/ECT on 10/20/2000 01:24 PM
---------------------------

Zimin Lu
10/20/2000 10:45 AM
To: Andrew H Lewis/HOU/ECT@ECT
cc: Colleen Sullivan/HOU/ECT@ECT, Stinson Gibner/HOU/ECT@ECT
Subject: level effect in transport

Andy,

The following spread sheet domenstrates the leve effect in transport
valuation.

I add an "NYMEX add-on" to both delivery and receipt price curve before fuel
adjustment, keep everything else the same. The transport value (PV of the
spread options)
increases when NYMEX add-on increases.

I can visit you at your desk if you have further question.

Zimin