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Electricity Options Volatility Skews and Upside Price Spikes

Article Quant Q&A · Author: Joao Serafim
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Summary

The document asks how implied volatility across strikes should behave for electricity options. It describes differing possibilities, including a convex smile and a skew with higher volatility at elevated strikes. The replies discuss German electricity market research and report an upside skew in which out-of-the-money calls and deep in-the-money puts carry higher implied volatility.

The proposed market mechanism is that power prices can jump upward when demand exceeds baseline supply, before additional generation becomes available. The cited discussion also notes that implied volatility can vary with strike and maturity, and that very short-dated options may show elevated values as prices and payoffs converge near expiration. These are qualitative observations rather than a universal calibration rule; the document gives no sample, model comparison, or quantitative evidence establishing that the described shape holds across electricity markets and periods.

Key ideas

  • Electricity options may exhibit an upside volatility skew, with elevated implied volatility at higher strikes.
  • The discussion associates this pattern with sudden price increases when demand outstrips available supply.
  • Implied volatility can vary across both strike prices and maturities.
  • Very short maturities may show elevated implied volatility near expiration.
  • The exchange offers qualitative explanations but no quantitative validation or universal rule.

Tags

OptionsVolatilityCommoditiesDerivatives pricing
Full text
# Electricity volatility smile


# Electricity volatility smile












In the electricity sector, what should be the shape of the volatility smile?

a behavior similar to other commodities with a convex curve, decreasing first and then growing to the initial level.

or

a volatility skew with volatilities elevated for higher strike prices ??

## Answer by KAT (score 2)

https://quant.stackexchange.com/a/8718

This article discusses the problem on the German electricity market.

They arrive at the following conclusion:"When the B&S model is used to calculate implied volatilities one often obtain different numbers for different values of K and T. In particular, a "smile" or "smirk" shape is often observed in the plot of implied volatility versus strike price. Implied volatility tends to increase with maturity time, but is often larger for options with very short maturities. This is due to the increase in price that sometimes occurs when options are close to maturity as the price and the payoff converge."

## Answer by jessica (score 2)

https://quant.stackexchange.com/a/8737

This is a great question that I actually had when I worked on the trading floor at this large energy company that traded power and other energy commodities.

Electricity has a volatility skew to the upside. So vol for OTM Calls/Deep ITM Puts trades at a premium. Mainly because prices have a tendency to shoot to the upside when load exceeds base demand until new supply comes online to absorb the new demand.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.