Immediate Settlement - This type of transaction is the most liquid, with daily bids and offers. The typical bids and offers are in 2,500 to 5,000 allowances lot increments, however smaller quantities as low as 1,000 allowances have been bid and offered. For this type of transaction, once a trade occurs, Natsource would notify the identity of the Party's counterparty. The Parties then would exchange contracts, which are fairly standard and a few pages long. Upon execution of the contract, the Seller would deliver a completed and executed ATF to the Buyer. The Buyer would then execute the ATF and forward the completed form to the EPA. Cash settlement or payment is usually to be made within 3 business days upon electronic or written confirmation by the EPA that the contracted allowances.

Immediate Vintage Year Swap - This type of transaction involves the exchange of a certain quantity of vintage year allowances for another quantity of different vintage year allowances. The ratio between quantities is called the Swap Ratio. The transfer of allowances between parties usually occurs within three business days of each other. An example of an immediate vintage year swap would be if one party transferred 10,000 vintage year 1999 allowances to another party and received immediately 10, 100 vintage year 2001 allowances in return. The Swap Ratio would be calculated and quoted as follows : (10, 100 - 10,000) / 10,000 = 1 % between vintage year 1999 and vintage year 2001 allowances, or 0.5% per year between vintage years. Normally, Swap Ratios are quoted against the current vintage year.

175 Day Deferred Allowance Swap - This type of transaction is similar to the Immediate Vintage Year Swap, except that the counterparty has 175 days to return the allowances. An example of this transaction would be if one Party transferred 10,000 vintage year 1999 allowances, and the counterparty transferred 10,100 vintage year 1999 175 days later. The market ratio for these type of transactions currently is 0.75% - 1% every 175 days for spot vintage year swaps (vintage 1999 - vintage 1999) and would increase as the vintage years differ. The reason for the 175 day time period is that IRS rules state that swaps closed within six months (180 days) are considered "like kind" exchanges, and do not trigger a taxable transaction. Natsource, however, advises each Company to determine their individual tax situation.

Allowance Loans - In this type of transaction, one Party loans allowances (usually current vintage year) to another Party for a period of 1- 5 years. An example of this transaction would be if one Party transferred 50,000 vintage year 2000 allowances on June 1, 2000, and received 52,000 vintage year 2002 allowances on June 1, the additional 2,000 being supplied by the borrower as loan interest. Good Investment grade credit is usually required to secure this type of transaction without posting security.

Forward Settlement - This type of transaction refers to when delivery and payment for an allowance transaction occur in the future. For example, if S02 allowance prices were $100.00 on January 1, 2000, and you wanted to purchase vintage year 2000 allowances and take delivery and payment on January 1, 2001, then it is possible to structure an agreement to purchase allowances on January 1, 2001 for a contract price of $106.00. The calculation of this future price is based upon how the market prices future deliveries and payments, which is usually a function of the market participants' cost of carry interest rate and the allowance loan rate. Forward price escalation in the S02 market is currently between 6% and 8% per annum for terms 1-7 years out. In the above example, the interest rate used was 6%. Forward settlement transactions allow market participants to lock in future purchases and sales at prices that meet their individual needs, while managing their cash flow requirements. Good investment grade credit is required to secure this type of transaction.

Call Options -
Buyer: Entitles the party to buy Allowances at a predetermined strike price on the expiration date. This position could be taken by natural shorts who need to hedge their price risk in case of rising prices. Risk is limited to the amount paid for the premium.
Seller: The party grants the right to the buyer, and collects the premium. The person has the obligation to sell the Allowances at a predetermined price, at the discretion of the call buyer. This position could be taken by a natural long firm who is satisfied by the strike price, and is using a covered call option premium to maximize the value of their long inventory.

Put Options -
Buyer: Entitles the party to sell Allowances at a predetermined price on the date of expiration. This position could be taken by a natural long to hedge their downside price risk. Risk is limited to the amount paid for the premium.
Seller: Grants the right to the buyer and collects the premium. Conversely, this person has the obligation to buy the Allowances at a predetermined price at the discretion of the put buyer. This position could be taken by a natural short firm who is satisfied by the strike price and is using the put option premium to help reduce his overall Allowance cost.

Collars (Zero Cost or Others) - A Collar enables someone to hedge against prices buy buying and selling a call and put option respectively. An example would be that you want to hedge against prices going above $200, so you buy a call option for $10. However, you would be willing to buy Allowances for $150, so you sell a put option for $10. The option Premiums cancel each other out, and you end up with a zero cost collar, 150 Put, 200 Call.

Strangles - A Strangle is when you buy both a Call Option and Put Option with different strike prices. One example would be if you are a generator and see yourself balanced (or flat) by the year 2001. However, if your load increases or decreases, you could potentially see yourself either long or short allowances. To protect yourself from rising allowance prices in case you need to buy allowances in the future, you purchase an Out of The Money Call Option. However, to protect yourself from decreasing allowance prices in case you have extra allowance to sell, you also purchase an Out of The Money Put Option. What you essentially did was purchase a Strangle, to hedge your price risk.

Sell allowances, Buy Call Option - This transaction, sometimes referred to as a Sales Reversal Provision, allows a participant to sell their allowances and simultaneously purchase a call option to hedge if prices rise dramatically. An example of this transaction is as follows:

Current Price Strike Price Expiration Date Option Premium $150.00 $175.00 Dec. 15, 2000 $15.00

With the above quotes on Dec. 15, 1999, the market participant would sell his allowances for $160.00 ($175-$15), and have a call option for an equal volume of allowances expiring on December 15, 2000 with a strike price of $175.00.

Buy allowances, Sell Put Option - This transaction allows buyers to purchase allowances below current prices, if they give the Seller the flexibility to sell additional allowances to them on a future date.

Current Price Strike Price Expiration Date Option Premium $150.00 $125.00 Dec 15, 2000 $8.00

With the above example, the buyer would purchase allowances $8.00 below current prices at $142.00, if the buyer gives the Seller the right to sell him an equal volume of allowances at $125.00 on Dec 15, 2000.

Dollar Cost Averaging: The strategy employs buying or selling allowances over an extended period of time. Although each of us has his or her own view on allowance prices, the simple fact is that no one really knows what will happen to prices. There are not many traders who consistently buy the bottom of a market and sell the top. Because of this, by setting up a strategy where you buy (or sell) over a period of time, you are hedging your price risk that prices move aggressively against you, and your average purchase price will be somewhat of the annual average price.

Selling Covered Call Options: Sellers who sell out of the money calls options are collecting premium against their allowance inventory. If prices stay stagnant or decrease, the seller receives the option premium. If prices move up and the call is exercised, the seller usually has more inventory, which now has a higher market value due to higher prices, and the seller then sells another call option.

Writing Covered Puts: Buyers who sell out of the put options are collecting premiums against their ability to buy allowances at certain prices. If prices stay stagnant or increase, the buyer receives the option premium. If prices move down and the put is exercised, the buyer usually has more to purchase, and has the opportunity to sell another put option or buy inventory at lower prices.