It depends on what your risk is to the upside. Without knowing what your payoff is to the upside it's unclear what hedge works. The cheapest hedge is to sell futures. No cost there. But if oil rallies and you have a fixed positive payout then the hedge.
how to hedge against oil price collapse?
- Thread starter toben
- Start date
It depends on what your risk is to the upside. Without knowing what your payoff is to the upside it's unclear what hedge works. The cheapest hedge is to sell futures. No cost there. But if oil rallies and you have a fixed positive payout then the hedge.
Without any more information there's no better hedge.
Without any more information there's no better hedge.
This is related so some of the Q&A earlier in the thread.
Do you need a full hedge and does it need to be put into place all at once?
I mention this for two reasons:
- If you've studied the 2008 oil price run up and collapse, you'll see that it took about five months to fall from $148 to $35. Then the market chopped around for a couple of months while the bank stress tests were happening. The price ascent began in Feb (closed about $45) and by May 2009 oil was back to the mid-60s.
- Someone's probably published a report with industry averages, but as an anecdote, I invest in the stock of a number of small E&P companies (common, MLPs, trusts), and I can't recall seeing a hedge figure much above 60-70% and it's often in the neighborhood of 50%.
Now, maybe you want to prepare for something even more severe and rapid than 2008. I don't know what you have in mind, but if recent history is any guide, you would likely have at least a month or two before everything went to hell. And if Martians invade, what's it matter anyway?
Do you need a full hedge and does it need to be put into place all at once?
I mention this for two reasons:
- If you've studied the 2008 oil price run up and collapse, you'll see that it took about five months to fall from $148 to $35. Then the market chopped around for a couple of months while the bank stress tests were happening. The price ascent began in Feb (closed about $45) and by May 2009 oil was back to the mid-60s.
- Someone's probably published a report with industry averages, but as an anecdote, I invest in the stock of a number of small E&P companies (common, MLPs, trusts), and I can't recall seeing a hedge figure much above 60-70% and it's often in the neighborhood of 50%.
Now, maybe you want to prepare for something even more severe and rapid than 2008. I don't know what you have in mind, but if recent history is any guide, you would likely have at least a month or two before everything went to hell. And if Martians invade, what's it matter anyway?
The full $500k exposure can be hedged with fifteen $90 crude futures puts.
The overall cost will depend on your time frame. For example, the Dec13 $90 puts cost ~$5.75 and the Dec14 $90 puts cost ~$10.10.
Total cost to hedge your $500k risk until Dec 2013 will cost (15,000x5.75) $86,250. Total cost to hedge this risk until Dec 2014 will cost (15,000x10.10) $151,500.
You can reduce this cost if you choose to sell calls, however I would recommend against this. The decision to explore selling calls would depend on your risk capacity and cash flows.
If crude falls to $60, the Dec13 $90 puts will be worth $30. They cost you $5.75, so you would net $24.25 (x15000), or a hedge profit of $363,750.
If crude falls to $50, the Dec13 $90 puts will be worth $40. They cost you $10.10, so you would net $29.90 (x15000), or a hedge profit of $448,500.
You can always get into a synthetic position whereby you sell the futures contract for a given expiration (Dec13 for example) and simultaneously buy a near the money call to mimic the P&L of the $90 puts. WTI especially is historically put skewed, so you may get into a cheaper position with the more complex synthetic.
Your choices will require different amounts of margin capital. If you would like to learn more or get the ball rolling on executing any of the above, feel free to PM me.
Implicit in your feeling the hedge is an absoloute imperative in your business is the assumption that crude pricing is your only or at least you primary risk and additionally that level of risk outweighs any alternate opportunity that could make your business soar.
I was retained as a cunsultant to act as the proxy CEO of a small precious metals firm when their primary lender discovered a substaintial and fraudulent kiting scheme by the CEO. I convinced the lender not to hedge the modest inventory position we maintained and to use those funds to expand the business instead. It involved a level of risk but so do most business decisions. I perceived the firms anemic marketing effort as the most likely aspect to sink the company.
My point here is that frequently markets seem to represent the greates risk to a company's prospects and sometimes that is true and frequently it is not.
I was retained as a cunsultant to act as the proxy CEO of a small precious metals firm when their primary lender discovered a substaintial and fraudulent kiting scheme by the CEO. I convinced the lender not to hedge the modest inventory position we maintained and to use those funds to expand the business instead. It involved a level of risk but so do most business decisions. I perceived the firms anemic marketing effort as the most likely aspect to sink the company.
My point here is that frequently markets seem to represent the greates risk to a company's prospects and sometimes that is true and frequently it is not.
+1
I think mostly it's not.
The Corporate Hedging Process
by Ian H. Giddy
(Adapted from an article published by Bank of Montreal)
http://people.stern.nyu.edu/igiddy/corphdg.htm
by Ian H. Giddy
(Adapted from an article published by Bank of Montreal)
http://people.stern.nyu.edu/igiddy/corphdg.htm
Why did commodities get slammed today ? Here is what I know about commodity prices:
1. Weakening/strengthening currency, they go up/down. Takes more dollars to buy the same unit volume.
2. Robust or weak economies, they go up/down as demand/lack of demand for them increase/decrease for industrial reasons.
3. Fundamental issues inside of a commodityâs sector can influence price as in supply issues.
QUESTION: Why did commodities go down today when none of the aforementioned issued happened ? From what I read, Cyprus news of selling gold reserves to get money was a tipping point that accelerated selling pressure, but was not the prime cause.
1. Weakening/strengthening currency, they go up/down. Takes more dollars to buy the same unit volume.
2. Robust or weak economies, they go up/down as demand/lack of demand for them increase/decrease for industrial reasons.
3. Fundamental issues inside of a commodityâs sector can influence price as in supply issues.
QUESTION: Why did commodities go down today when none of the aforementioned issued happened ? From what I read, Cyprus news of selling gold reserves to get money was a tipping point that accelerated selling pressure, but was not the prime cause.
In the short run, price is affected most by TA, in the longer run FA. TA can predict a weakening of demand that causes more sellers to sell commodities then buyers are willing to buy, thereby lowering the price.
I think the banks gave a bad forcast, not enough to move price on its own,
also Bernake, I think mentioned stopping the printing press. Also inflation has been absent. A lecture form a university I saw was explainging that inflation is not always a sign of inflation and such thinking is shown in the price of gold.
This did not all happen today.
Some how we broke out of a range, causing panic.
meanwhile, Texas changes it's legislation to allow for investment in physical gold that is not protect from government confiscation.
I wont go in to bit coins, but one should keep an eye on it. it is after all a market with few buyers and sellers and seen by some as a hedge against the same thing gold is a hedge against.
It was a good precursor if you offer it any respect.
on the topic of hedging, if we were to see a comodity to drop by 50% what advantage would future option have over simply taking an opposite position?