Download Financial Derivatives and Hedging

Oil Futures Market
Hedging & Price Management
August 13, 2017
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Outline

Types of Financial Instruments

Jargons

Usages of Financial Instruments

Trading Failures
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Types of Financial Instruments



Forward Contract
Futures Contract
Derivatives
1. Options
 Calls
 Puts
2. Swaps
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Forward Contract
“A supply
contract between a buyer and
seller, whereby the buyer is obligated
to take delivery and the seller is
obligated to provide delivery of a fixed
amount of a commodity at a
predetermined price on a specified
future date. Payment in full is due at
the time of, or following, delivery.”
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Future Contract
“A supply
contract between a buyer
and seller, whereby the buyer is
obligated to take delivery and the
seller is obligated to provide
delivery of a fixed amount of a
commodity at a predetermined
price at a specified location.”
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Futures Contracts - Characteristics
Regulated
 Small lots
 Monthly quote
 Price transparent
 Clearing house
 Margin money required
 Not always physical

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Options
“a right – but not an obligation- to buy or sell
an underlying asset at a fixed price during a
specified time period in exchange for a onetime premium payment.”
Call
 Put

: the option to buy
: the option to sell
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Where are They Traded ?
NYMEX (US)
IPE (London)
Light sweet crude (WTI) Brent
Heating oil (No 2)
Gasoil
Gasoline
Natural Gas
SIMEX (Singapore)
Fuel Oil
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Jargons

Contango vs. Backwardation

Long vs. Short

Bull vs. Bear
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Contango
If at any point in time…
Market prices RISE through future months…
Then the market is in CONTANGO
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Backwardation
If at any point in time…..
Market prices FALL through future months…
Then the market is in BACKWARDATION
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2n th
d
M
t
3r h
d
M
th
4t
h
M
th
5t
h
M
t
6t h
h
M
t
7t h
h
M
th
8t
h
M
th
9t
h
M
10 th
th
M
11 th
th
M
12 th
th
M
th
tM
1s
$/tonne
IPE Gasoil Curve
260
240
220
200
180
160
140
120
100
3-Aug-98
1-Aug-00
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Pay Out Diagram – Long Position
Buy AXL @ 30$/bbl
Profits $
4
3
2
1
0
-1
-2
-3
-4
Profits as Market rises
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27
Losses $
28
28
29
29
30
31
32
33
$/bbl
Losses as Market falls
Market Price
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Pay Out Diagram – Short Position
Sell AXL @ 30$/bbl
Profits $
4
3
2
1
0
-1
-2
-3
-4
Profits as Market falls
31
27
Losses $
28
29
30
31
32
32
33 $/bbl
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Losses as Market rises
Market Price
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Use of Financial Instruments
1.
Speculation
2.
Hedging
3.
Price Management
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Speculation

Outright position taking

Pure paper traders

Directional price movement
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A Speculative Market
IPE Brent Crude futures Total Traded Volume
January 1998 - October 2000
lots
3/2/00
1/2/00
11/2/99
9/2/99
7/2/99
5/2/99
3/2/99
1/2/99
11/2/98
9/2/98
7/2/98
5/2/98
3/2/98
1/2/98
160000
140000
120000
100000
80000
60000
40000
20000
0
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Hedging
Definition:
Taking an opposite position on futures to
that on physical to remain…
“PRICE NEUTRAL”
 Objective:
“TO REDUCE RISK”

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Hedging - Example









It is October 29th.
A trader loads a gasoil cargo ex-Yanbu.
The FOB price is $270/ton.
His freight cost is $15/ton.
He also has agreed to sell it CIF to a buyer in
Rotterdam at Platts 0.2%S CIF on arrival.
Vessel is due Rotterdam November 9th.
Today, Platts 0.2%S CIF price is $293/ton
IPE December Futures price for gasoil is $291/ton.
The trader intend to make $8/ton in profits.
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Hedging – Example (continue)

Hedging plan (Part I)
 When the physical is priced in, he should
sell futures (October 29th)

Action: 1. Buy physical @ $270/ton
2. Sell Futures @ $291/ton
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Hedging – Example (continue)
Hedging plan (Part II)
When the physical is priced out, he
should buy futures (November 9th)
 On November 9th,
 Platts CIF Cargoes price is
$280/ton
 IPE December Futures price is $278/ton
 Action: 1. Sell physical @ $280
2. Buy Futures @ $278

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Hedging – Example (continue)
Accounting
Physical
FOB
Purchase
Fright
$/ton
-270
CIF Sale
280
Net
-5
-15
Futures
Sell on
Oct. 29th
Buy on
Nov. 9th
$/ton
+291
Net
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OVERALL NET = +$8/TON
-278
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Price Management
Definition:
Using futures and forward markets as a
vehicle to…
“CATCH THE MARKET”
 Objective:
“LOCKING IN A PRICE”

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Price Management - Example





It is November 1st
A Japanese refinery is due to load Dubai crude
on December 15th
As usual, price will be determined 5 days around
B/L
Buyer fear that crude prices are increasing next
month and would like to lock current price
Action:
1. Buy Dubai futures now
2. Sell Dubai futures at time
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physical is priced
Why Do You See Trading Failures?
Failure to understand risk & exposure
 Poor organizational structure
 Excessive speculation
 No position tracking
 Absence of controls
 Extreme market volatility

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80
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84
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86
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90
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92
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96
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98
20
00
Crude Oil Prices
40
$/BBL
35
38
Dubai
Brent
WTI
30
25
20
15
10
5
0
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Crude Oil Price Volatility
16.0
WTI ($/BBL)
23-Mar
15.5
15.0
10-Mar
14.5
14.0
9-Mar
13.5
13.0
24-Feb
12.5
4-Mar
3-Mar
17-Mar
OPEC
Meeting
(Vienna)
18-Feb
12.0
11.5
11.0
16-Feb-99
23-Feb-99
2-Mar-99
9-Mar-99
16-Mar-99
23-Mar-99
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Summary
Many financial instruments
 Three motives to use financial instruments.
 There is a distinct difference between
hedging and speculation
 Hedge to reduce risk
 Trading Failures

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