DEFINITION of 'Swing Option'

A type of contract used by investors in energy markets that lets the option holder buy a predetermined quantity of energy at a predetermined price while having some flexibility in the amount purchased and the price paid. A swing option contract states the least and most energy an option holder can buy (or "take") per day and per month, how much that energy will cost (its strike price) and how many times during the month the option holder can change (or "swing") the daily quantity of energy purchased.

BREAKING DOWN 'Swing Option'

Swing options, also called swing contracts, take-and-pay options or variable base-load factor contracts, are most commonly used for the purchase of oil, natural gas and electricity. They can be used as a hedge by the option holder to protect against price changes in these commodities.

For example, a power company might use a swing option to manage changes in customer demand for electricity that occur throughout the month as temperatures rise and fall. These contracts are more intricate than they appear to be, making their valuation challenging.

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