The dynamics of oil prices and valuation of oil derivatives

Over the last three decades financial derivatives, such as futures and options, have become increasingly important to financial institutions for the purposes of trading and risk management. In particular, commodity markets have undergone significant growth in terms of volumes and diversity of traded contracts. The most significant development since 2000 has been in the trading of commodity options. The London International Petroleum Exchange (IPE) and the New York Mercantile Exchange (NYMEX), as well as other exchanges, regularly introduce futures and options contracts on different commodity products. Further, the growth of over-the-counter trading in physical commodity options, such as oil, is increasing rapidly. The values of most financial derivatives asre based on the movement of the underlying assests on which the derivatives are written. Consequently, it is not a trivial task to quantify their price, although mathematics provides a powerful tool in order to do so.