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On the Structure of a Swing Contract's Optimal Value and Optimal Strategy

Part of: Operations research and management science

Published online by Cambridge University Press:  14 July 2016

Sheldon M. Ross  and
Zegang Zhu
Sheldon M. Ross*
Affiliation:
University of Southern California
Zegang Zhu*
Affiliation:
University of California, Berkeley
*
∗Postal address: Daniel J. Epstein Department of Industrial and Systems Engineering, University of Southern California, 3715 McClintock Avenue, GER 240, Los Angeles, CA 90089-0193, USA. Email address: smross@usc.edu
∗∗Current address: 100 W 93rd St., Apt. 27E, New York, NY 10025, USA. Email address: zhuzgang@yahoo.com
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Abstract

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Consider a sales contract, called a swing contract, between a seller and a buyer concerning some underlying commodity, with the contract specifying that during some future time interval the buyer will purchase an amount of the commodity between some specified minimum and maximum values. The purchase price and capacity at each time point is also prespecified in the contract. Assuming a random market price process and ignoring the possibility of storage, we look for the maximal expected net gain for the buyer of such a contract, and the strategy that achieves this maximal expected net gain. We study the effects that various contract constraints and market price processes have on the optimal strategy and on the contract value. We show how we can reduce the general swing contract to a multiple exercising of American (Bermudan) style options. Also, in important special cases, we give explicit expressions for the optimal contract value function and the optimal strategy.

Keywords

Swing contractAmerican call optionoptimal strategysupermodularsubmodular

MSC classification

Secondary: 90B50: Management decision making, including multiple objectives 90C40: Markov and semi-Markov decision processes
Type
Research Article
Information
Journal of Applied Probability , Volume 45 , Issue 1 , March 2008 , pp. 1 - 15
Copyright
Copyright © Applied Probability Trust 2008 

Footnotes

Supported by the National Science Foundation, grant ECS-0224779, the University of California, and by a grant from OpenLink Financial Inc.

Supported by the National Science Foundation, grant ECS-0224779, and the University of California.

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