Hedging Strategies in Commodity Markets – Rolling Intrinsic and Delta Hedging for Virtual Power Plants

ABSTRACT

Hedging on commodity markets is usually done by applying either the rolling intrinsic strategy or the canonical delta hedge strategy. In this paper we introduce, compare and discuss both hedging strategies in the context of virtual power plants (VPP). We formulate the precise relationship of the two strategies mathematically. Our main result is that they are not only very similar regarding hedge construction but also that both strategies are equal in expectation. The proof involves some stochastic calculus and the Brownian local time. We illustrate our findings with simulated data as well as in prototypical market scenarios. These studies show that the rolling intrinsic hedge comes with a riskier profile than the delta hedge.

KEYWORDS:

• Stochastic modelling of energy markets
• hedging strategies
• virtual power plants
• rolling intrinsic hedging
• delta hedging

Acknowledgments

The author wants to thank Dr. Christian Menn (Rivacon GmbH) for many fruitful discussions.

Disclosure statement

The author reports no conflict of interest. The author alone is responsible for the content and writing of this paper.

Notes

1. There is some naming ambiguity here. Sometimes also the bundling of a number of small, mostly renewable, power production facilities is called Virtual Power Plant.

2. Another naming ambiguity, not to be confused with credit default swaps.

3. This simplification is the starting point for many studies, see for example Bann et al. (2016) or Andreis et al. (2020).