Crude Oil Hedging by USA Energy Security Analysis Inc

By USA Energy Security Analysis Inc

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Sample text

As a result, as Charts 16 and 17 show, Asian options tend to be somewhat cheaper than American options. Thus, a crude oil producer can buy a Nymex option at a strike price of, say, $20 for a crude contract that expires in, say, three months. He may exercise that option at any time up to and including the day of expiration. Or, the producer may buy an average put option (over the counter, as Nymex does not sell these) for a calendar month. If average spot (or nearby Nymex) prices during that month are lower than the option price, the option seller must buy a crude contract from the put holder.

6 Â < previous page < previous page page_32 page_33 next page > next page > Page 33 Producers who sell forward leave money on the table in a backwardized (but otherwise neutral) market. The amount by which a call will reduce the hedging loss depends on when the call is sold. It will be the most effective when the market goes up and also when volatility is high. Backwardation has been shown to lead to increases in volatility in energy prices. To profit from this effect, the option holder would have to sell the option well before expiration day to capture time value.

In this case, a hedger is interested in buying crude oil company Y sells a call at a higher strike price and buys a call at a lower 39 40 Â < previous page < previous page page_26 page_27 next page > next page > Page 27 price. In this case, the strategy is designed to protect the buyer in a rising market. Assume the same facts as above the underlying price is $20, but in this case the buyer is concerned the price will rise. Company Y buys a call at $19 for, say $2, and sells a call at $21 for, say, $1.

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