Tunnel Option

Let's build on the hedge example. For this example, rather than comparing the measured usage to a single reference curve, the usage will be compared to a range of values at each interval to see if it falls within the range or outside the range. This is sometimes known as a "tunnel" option or a hedge option with "flex" parameters.

Assume that the interval rate for this option has the following conditions.

• For each interval, if the measured usage falls WITHIN the tunnel, the measured amount will be priced at a fixed price.
• For each interval, if the measured usage falls BELOW the LOW tunnel value, the customer will pay the low tunnel value at the fixed price AND will receive a credit for the difference between the low value and the measured amount at a market price.
• For each interval, if the measured usage falls ABOVE the HIGH tunnel value, the customer will pay the high tunnel value at the fixed price AND will pay for the measured amount over the high tunnel value at a market price.

Before we start looking at the data setup, let's talk about how the "tunnel" will be defined. In most cases, each customer does NOT have their own high and low tunnel curves defined. Instead, customer has a "reference curve" (also called "hedge cover") and the high and low values are defined as standard values for your company. These are percentages.

In this example, we assume that the actual usage, the hedge cover, the strike price and the market price are all interval curves with the same interval size.