The formula which we are using is a specific formula for pricing HDD Call Options using Monte Carlo Simulations. This formula is a variation of Black Scholes option pricing model which is a widely used model for pricing financial options.
Derivative
where,
CHDD = Price of the HDD Call Option
e-r(T2 - T1) = discount factor, which accounts for the time value of money and reflects the present value of future cash flows.
Np = Principal Nominal, which is a multiplier for the payout
max(HDDs(T1 - T2) - K, 0) = Calculates positive difference between the cumulative HDD during the specified period and the strike level
K = Strike level or threshold for the cumulative Heating Degree Days (HDDs)
For more info. refer to this article.
