Strategies · Library · Weather, energy, inflation
§14.4Pairs and relative value
Energy – spark spread
The spark spread is the power price minus the gas cost to generate it, using the plant's heat rate. Short electricity futures and long gas futures to hedge a gas-fired plant or bet on its margin. Contract sizes force the hedge ratio to be rounded to a small whole-number ratio.
- Asset class
- Weather, energy, inflation
- Held for
- Varies
- Data
- ARCANE has part of the data
- Symphony
- Cannot be built as a symphony
The rule
- Signal
- Electricity price minus heat rate times gas price.
- Entry and exit
- Open the electricity and gas legs together in the rounded ratio; hold to expiry or until the spread moves.
- Sizing
- Whole-number ratio of gas to power contracts from heat rate and contract sizes.
How it fails
- Power price spikes
- Rounding in the hedge
- Plant outages
Data it needs
- electricity futures
- natural gas futures
- heat rate
ARCANE has front-month natural gas (UNG, NG=F) but no electricity prices.
How ARCANE uses it
A Call on gas prices could read the spread as a margin signal if power data were added.
Needs electricity prices and a short leg.
Filed under the pairs and statistical arbitrage card
Find two securities whose prices moved together for a year. When the gap between them opens past two standard deviations, buy the laggard and sell the leader.
A paper plan from this card holds 5 to 126 days, stops at 1.5× the expected move and uses at most 50% of your risk budget. The card
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §14.4, p. 109 of the SSRN version. Described in our words. Pairs and relative value is ARCANE’s filing, not the book’s.