Expectations for Statistical Arbitrage in Energy Futures Markets

Abstract

Energy futures have become important as alternative investment assets to minimize the volatility of portfolio return, owing to their low links with traditional financial markets. In order to make energy futures markets grow further, it is necessary to expand expectations of returns from trading in energy futures markets. Therefore, this study examines whether profits can be earned by statistical arbitrage between wholesale electricity futures and natural gas futures listed on the New York Mercantile Exchange. On the assumption that power prices and natural gas prices have a cointegration relationship, as tested and supported by previous studies, the short-term deviation from the long-term equilibrium is regarded as an arbitrage opportunity. The results of the spark-spread trading simulations using historical data from 2 January 2014 to 29 December 2017 show about 30% yield at maximum. This study shows the possibility of generating earnings in energy futures market.

Energy Derivatives- An Analysis of the Turkish Electricity Market

“…Energy resources such as oil, gas and coal are consumed by companies in each country, although they cannot control the risks of price fluctuations on their own. Therefore, there are high expectations for energy derivatives as most market participants seek to minimize the volatility of investment returns (Nakajima, 2019). On the other hand, this type of futures are highly liquid contracts arising from the increased involvement of hedgers and speculators in the market (Silber, 1985).…”

How to Promote Energy Transition With Market Design: A Review on China’s Electric Power Sector

“…1) Controlling the risks and ensuring the energy security: A mature and perfect power market should include the power futures market which is an effective supplement to the existing wholesale and retail power markets (Wang et al, 2019b). The power futures market can provide a platform for the price fluctuation management and the risk reduction in power market transactions (Nakajima, 2019). Of note, the development of futures trading in the power market will play a positive role in the risk management and control, which can help enterprises avoid risks to a certain extent through hedging and other applications (Du et al, 2018).…”

“…Of note, the development of futures trading in the power market will play a positive role in the risk management and control, which can help enterprises avoid risks to a certain extent through hedging and other applications (Du et al, 2018). The power futures market has the market function of price discovery which can guide the power market investment rationally (Nakajima, 2019). In addition, both the electricity producers and the consumers can have a relatively accurate estimate of both the future production costs and the future consumption costs since participants can sign long-term power futures contracts in advance.…”

Machine Learning in Futures Markets

“…Simon (1999) studies a spread-trading arbitrage strategy by examining the relationships between soybean futures and their respective end products. Based on the assumption of a cointegration relationship between wholesale electricity futures and natural gas futures, the strategy of Nakajima (2019) trades deviations from the short-term equilibrium and yields profits of around 30 percent at maximum. As one of the first applications of financial machine learning in future markets, Dixon et al (2017) leverage a deep neural network to predict the price changes of futures over a 5 minute time window.…”