Commodity Futures and Options

Transcription

1 Commodity Futures and Options ACE 428 Fall 2010 Dr. Mindy Mallory Mindy L. Mallory 2010

2 Rolling a hedge Definition To continue to hedge for additional months beyond the expiration of the original contract Done by offsetting original contract Simultaneously taking new position in a more distant month The forward price of the hedge is switched to a more distant maturity

3 Rolling a hedge When would you do this? Have storage facilities and flexible cash-flow See an opportunity to obtain additional returns from storage

4 Producer is planning to sell corn in December On June 2 nd, 2006 hedges using Dec 06 futures Short Dec 06 = $2.85/bu Expected basis for Dec 06 = -$0.20 Brokerage fees = $0.01/bu Suppose it is historical or you have information that makes you believe this

5 Producer goes short in Dec 06 contract Expected spot price at time of maturity = $2.65/bu ($2.85 $0.20)

6 On Aug 16 th, 2006 Dec 06 futures price = $2.38 Mar 07 futures price = $2.52 Storage costs = $0.03/mo Expected basis for Mar 07 = -$0.15 Assume this is the full costs involved in carrying or storing Again, your belief about the basis The Dec-Mar spread indicates the market is offering $0.14/bu premium for storing to March

7 Producer rolls hedge to Mar 07 Went short in Mar 07 for $2.52 Offsets Dec 06 contract Went long in Dec 06 for $2.38 Stores grain from December 06 to March 07 Cost to store until March: $0.03 X 3mo = $0.09/bu

8 Put it all together: The Mar 07 futures price was $3.90 Suppose the realized basis in March 07 was -$0.15 at the producers location: Spot price in March 07 = $ = $3.75/bu Suppose the realized basis in December 06 was -$0.20 Spot price in December 06 = $ $0.20 = $2.18/bu

9 Put it all together: Gain/loss from the Dec 06 hedge: $ $ $0.01 = $0.46/bu Gain/loss from the Mar 07 hedge: $ $ $0.01= -$1.39 Gain in the spot market (In March): $3.75/bu $0.09/bu = $3.66 Why is this here?

10 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar = -1.39

11 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar = -1.39

12 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar = -1.39

13 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar = -1.39

14 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar = Net 2.73

15 Put it all together: Overall revanue: $ $ $3.66 = $2.73 June 2 nd 06 Aug 16 th 06 Mar 14 th (Mar 07 maturity) Cash Sold physical 3.75 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec Sold Mar Net = = 0.46 Bought Mar carry cost for 3 months = brokerage fee

16 Suppose he didn t roll the hedge I.e., he offset his Dec 06 position and sold in the cash market in December (Like the examples we ve had before today)

17 Gain/loss from the Dec 06 hedge (Assuming 2.38 was the price of Dec 06 at maturity) $ $ $0.01 = $0.46/bu (Same as before) Gain in the spot market (in December) $2.18/bu Overall revenue: $ $2.18 = $2.64/bu Why no storage here?

18 Overall revenue: $ $2.18 = $2.64/bu June 2 nd 06 Dec14 th 06 Net Cash -- Sold physical 2.18 Futures Dec 06 Futures Mar 07 Sold Dec Bought Dec = Net 2.64

19 By rolling the hedge forward, made $ $2.64 = $0.09/bu more than he would have if he just closed out his position in December

20 How did he make extra money? Correctly anticipated that the basis would narrow (increase in absolute terms) And knew the cost of storing until March was sufficiently low He could roll the hedge forward and take advantage in the change in basis

21 Rolling a hedge forward: Review Rolling a hedge forward is exchanging your current position for one in the more distant future Another way to bet on basis If basis narrows (or increases ) the short hedge (or example) makes money Rolling the hedge forward allows you to take advantage of basis changes when you have already taken a position

22 Margins and Hedging Cash-Flow We have seen that there are margin requirements in futures markets Hedgers must have funds available when they place a trade in the futures market Initial margin deposit

23 Margins and Hedging Cash-Flow They may also need more funds while they have open positions Margin calls if their position is losing money

24 Margins and Hedging Cash-Flow Idea of hedging losses in the spot market are offset by gains in the futures market Gains in the spot market are offset by losses in the futures market Margin calls

25 Margins and Hedging Cash-Flow Possible gains in the spot market are only realized at the end of the hedging period, while losses in the futures markets are realized daily

26 Margins and Hedging Cash-Flow Even though your gains in the spot market will offset your losses in the futures market, you still need to borrow funds to meet the margin call and maintain the hedge

27 Margins and Hedging Cash-Flow So there is an extra cost of hedging, which is the need to borrow funds to meet margin calls

28 Margins and Hedging Cash-Flow Possible problems You may not find any financial institution willing to lend funds to you The borrowing costs (interest rate) may be too high If you cannot borrow funds to meet the margin calls you have to close the futures position and you are no longer hedged