Valuation of Spread Options Based on Monte Carlo Simulation and Its Relationship with Asset Correlation

Spread options are relatively young derivative products yet have a growing importance in the financial market for their frequent occurrence in energy derivatives. Two typical types of spread options are spark spreads and crack spreads. The crack spreads define the spread as the price difference between crude and refined oil, offering oil refiners insights into their marginal profits, while spark spreads are the difference between electricity and natural gas, enabling utility companies to predict future profitability. In this paper, we investigate the valuation of spread option products based on the Margrabe model with the Monte Carlo Simulations method. Specifically, two assets are selected (i.e., General Motor Company and Chesapeake Energy) to simulate spark spread. According to simulations, correlation and values of options are inversely related. In this case, it indicates that it will generate more profit when the correlation becomes smaller, and investors can find a balance between profits and safety by selecting stocks with different correlations. Overall, these results shed light on guiding future exploration focusing on spread option pricing.