Take the 2-minute tour ×
Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It's 100% free, no registration required.

I tried a search with google but I can't find a clear definition of what a Heat Rate Option is.

I would appreciate if someone could explain to me what this type of option is.

My understanding is that it has to do with energy options but I am not sure on the underlying.

share|improve this question

2 Answers 2

up vote 5 down vote accepted

That's a complicated subject. Unless you're on the trading desk of a power/chemical/refinery company, you probably won't find much information. In addition, if your company doesn't have the "marginal" (best) equipment, such that you compete on efficiency/price, you'll only watch from the sidelines.

Here's a previous discussion:


Keep in mind that some plants produce electricity by simply burning coal. Some by gas fired turbines with secondary heat recovery. Some by other means. And, some of those plants produce only power while others produce products (power is a sideline). The economics of each plant is different, and those numbers change rapidly. As a result, pricing a plant specific heat rate versus a market heat rate can be a real humbling experience.

I've watched that game from the sidelines long enough to know that I don't know anything about it.

Edit 1 ======================

Some additional links:







share|improve this answer
bill_080 Thank you very much for the response. The documents you provided look promising on getting at least basic understanding of the issue. –  Financial Economist Aug 17 '11 at 14:01
Unfortunately it looks like most of these links are now dead. –  SRKX Feb 3 at 10:03

A Heat Rate Option is a standard contract traded bi-laterally or on an exchange where the ratio between Electricity at an agreed location and Natural Gas at an agreed location is the strike price for an agreed quantity at an agreed expiration date.

This allows holder the ability to manage the the cost of the Market Implied Heat Rate.

For example if May Henry Hub is \$2.50 mmBtu and ERCOT South Power is \$25.00 MWh, then the Market Implied Heat Rate is 10. An option holder may want to buy a call with a strike price of 12, so they are capped from the risk of higher Market Implied Heat Rates.

The above whitepapers address the operational heat rate performance of a generating plant, which is difficult to replicate in the secondary physical or derivative markets.

share|improve this answer

Your Answer


By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.