I understand the concept but hard to understand its application. It says"Lets say an oil producer might have signed an agreement to deliver a fixed amount of oil each month for the next year at some fixed price. One method of hedging is to go long in a series of futures contract with delivery dates and quantity matching the agreement" Now think about this. I am an oil producer , producing 100 barrels of oil each month and I have signed a contract to sell it for $ 50 every month for the whole year. If I enter into a futures contract ( long) for each month, wouldnt i recieve another 100 barrels of oil every month( Anybody long a futures expects to recieve oil in the future). So now I have 200 barrels ( 100 I produced and 100 through futures). Why would I enter as a long into the contract? Hope my question is clear.
it sounds like the producer already has entered into what basically amounts to having sold futures for the next year at a fixed price. if he thinks that oil prices are going higher, he may want to hedge by going long the futures to offset the commitment, then sell the oil he has at the higher price he anticipates. that’s how i see it. didn’t read it in the book so i’m not sure if that’s how the cfai wants us to see it.
I’m making this up as I go along so dont quote me, It seems to me that his position is already hedged. Fixed quantity, fixed price, fixed future date. So by taking out a hedge he is effectively gaining exposure to price movements. Maybe thats what he wants to do? Also, the future can be cash settled, so he doen’t need to take delivery of the underlying.
Is “strip hedge” a hedge, or is it to remove the hedge?
What is “strip hedge” trying to hedge? Hedge the basis risk by taking the price risk?
deriv108 Wrote: ------------------------------------------------------- > Is “strip hedge” a hedge, or is it to remove the > hedge? Strip hedge is a series of hedges. It does not remove any hedge. For example, if the oil producer has to supply 80 barrels in each month for 12 months. He enters into 12 contracts, one for each month.
deriv108 Wrote: ------------------------------------------------------- > What is “strip hedge” trying to hedge? Hedge the > basis risk by taking the price risk? Hedge price risk I believe.
“Lets say an oil producer might have signed an agreement to deliver a fixed amount of oil each month for the next year at some fixed price. One method of hedging is to go long in a series of futures contract with delivery dates and quantity matching the agreement”. I believe the quote is from SchweserNotes and it’s been there since 2009. So it’s not like a typo. It’s also similar to the example in the curriculum. Let say the oil price decreases, the oil producer will sell oil at lower price and lose money from the long futures. When the oil price increases, he sells oil at a higher price and gains from the long futures. This is hardly a hedge for price risk.
If this “oil producer” is an oil importer or have a problem to produce the oil(operational risk?), then all make sense.
Oxford Handbook of International Financial Terms: Strip Hedg Using a series of futures contracts with different expiry dates to match and hence hedge a cash position (cf. piled-up rolling hedge). For instance, an oil producer might use the crude oil futures to lock in his selling price for the next twelve months by selling futures of the four different contracts which expire over this period. Since demand for oil is seasonal, he may choose to sell more of the September and December contracts to reflect the expected higher demand going into the winter. Read more: http://www.answers.com/topic/strip-hedge#ixzz1HrO9Cmvm