The payoff of Quanto Options can be generalized as follows:
(Energetic commodity Index - Energetic commodity Strike) x (Temperature Index – Temperature Strike)
However, the payoff structure can be modified in different ways in order to improve product efficiency in hedging risks.
For instance, one could:
- Multiply it by a Notional Amount
- Choose a Call structure instead of a Swap
- Choose a Put structure instead of a Swap
The most common underlying selected as temperature index are:
- HDD - Heating Degree Day: calculated as the difference between average daily temperature and a threshold value, generally 18°C. This index is used to manage temperature exposure in the winter period.
- CDD - Cooling Degree Day: the equivalent of HDD for the summer period.
- CAT – Cumulative Average Temperature: the sum of the temperatures recorded over a period.