4. Hedging Using Futures Summary Why hedge How to hedge What is the optimal hedge Charles cao
1 Charles Cao 4. Hedging Using Futures ◼ Summary ◼ Why Hedge ◼ How to Hedge ◼ What is the Optimal Hedge
Why hedge? Objective: Neutralize the risk a An example A firm is due to sell an asset at a particular time in the future. The firm can hedge by shorting a futures contract Charles cao 2
2 Charles Cao Why Hedge? ◼ Objective: Neutralize the risk ◼ An example: ◼ A firm is due to sell an asset at a particular time in the future. The firm can hedge by shorting a futures contract
Why hedge? If the price of the asset goes down the firm will lose money when it sells the asset, but gain on the short futures position If the price of the asset goes up, the firm will gain from the sale of the asset, but will take a loss on the futures position Charles cao 3
3 Charles Cao Why Hedge? ◼ If the price of the asset goes down, the firm will lose money when it sells the asset, but gain on the short futures position ◼ If the price of the asset goes up, the firm will gain from the sale of the asset, but will take a loss on the futures position
Short Hedges a Involves a short position in the futures contract It is appropriate when the hedger owns the asset and expects to sell it in the future It is also appropriate when the hedger does not own the asset now but will own it in the future Charles cao
4 Charles Cao Short Hedges ◼ Involves a short position in the futures contract ◼ It is appropriate when the hedger owns the asset and expects to sell it in the future ◼ It is also appropriate when the hedger does not own the asset now, but will own it in the future
Short Hedges: Example Today, May 15 Exxon signed a contract to sell 1 million barrels of oil. The selling price is the spot price on august 15 Spot Price: $19/barrel August oil futures price: $18.75/barrel Charles cao
5 Charles Cao Short Hedges: Example ◼ Today, May 15 ◼ Exxon signed a contract to sell 1 million barrels of oil. The selling price is the spot price on August 15 ◼ Spot Price: $19/barrel ◼ August oil futures price: $18.75/barrel