Derivative Products

Trading across different carbon instruments (CERs, EUAs, ERUs etc) introduces relative price risk. Spread options take into account the correlation structure between two assets, reducing the number of option trades needed to express a view and therefore the cost.

By taking the correlation structure between EUAs and CERs into account, an EUA-CER spread option can be used to manage 'relative price risk' and compete at a price and performance level with both Swaps, Puts and Call Options.

The EU hopes to finalise negotiations concerning a successor to the Kyoto Protocol, which will cease post 2012, at the 2009 UN climate change conference in Copenhagen, Denmark.

The result of the Copenhagen negotiations will outline the third phase for the EU Emissions Trading Scheme (ETS) with expectation being for a much tighter cap on EUA allocations and more stringent limits on the use of flexibility mechanism credits for compliance within the EU. Full banking of Phase II EUAs is also expected to be endorsed and in addition it is seen as likely that Phase III EUA allocations will be subject to a higher level of auctioning opposed to an inclusive free allocation. With this in mind trading Phase III options is an efficient way to mitigate ones 'Copenhagen risk'.

Price risk management is a recurring theme in a growing global carbon market that often necessitates exposure to more than one carbon asset at a time. Swapping between carbon assets is a fundamental way to manage relative price risk. Gemini currently trade 'One-for-One' and 'Ratio Swaps' across the following assets: EUAs, CERs, ERUs and AAUs.

An option on a carbon swap, a Carbon Swaptions, competes with other spread related products and is an additional tool for managing relative carbon price risk.

Significant volumes of EUA Options trade within the EU ETS to hedge current outright positions and/or to efficiently implement a view on future price forecasts.

Under article 12 of the Kyoto Protocol the flexibility mechanism known as the Clean development Mechanism (CDM) permits an industrialised country (Annex I) to invest in emission abatement projects in a developing country whereby Certified Emission Reductions (CERs) will then be earned.

Project owners therefore have a large exposure to the market price of CERs. The prudent way for project owners to hedge their CER portfolio exposure whilst still participating in price gain in the market, is by using CER Options. Gemini has modelled and implemented some of the largest CER Option structures to date.

Under article 6 of the Kyoto Protocol the flexibility mechanism known as Joint Implementation (JI) permits a country (Annex II), with an emissions cap or commitment under the protocol, to generate Emission reduction units (ERUs) via an emission abatement project in another Annex II country.
In a similar way to CDM projects, JI projects leave owners exposed to price risk which can be mitigated by the emerging ERU Options market.