Title: Cash-settled options for wholesale electricity markets,
Abstract: Wholesale electricity market designs in practice do not provide the market
participants with adequate mechanisms to hedge their financial risks. Demanders
and suppliers will likely face even greater risks with the deepening
penetration of variable renewable resources like wind and solar. This paper
explores the design of a centralized cash-settled call option market to
mitigate such risks. A cash-settled call option is a financial instrument that
allows its holder the right to claim a monetary reward equal to the positive
difference between the real-time price of an underlying commodity and a
pre-negotiated strike price for an upfront fee. Through an example, we
illustrate that a bilateral call option can reduce the payment volatility of
market participants. Then, we design a centralized clearing mechanism for call
options that generalizes the bilateral trade. We illustrate through an example
how the centralized clearing mechanism generalizes the bilateral trade.
Finally, the effect of risk preference of the market participants, as well as
some generalizations are discussed.