Question

(1) What is a fixed price contract? Is the NYMEX WTI Crude oil Futures contract a fixed price contract? Explain why or why not using an example.

(2)Explain whether or not a fixed price contract can hedge a physical at index position. Or vice versa.

Please answer both parts.

Answer 1

The fixed price contract is a contract wherein the cost of purchase remains fixed no matter what other than any covenants applied to the contract on contingency.

Yes, NYMEX WTI Crude oil futures are fixed price contract.

In the definition above we have defined fixed price contract as the cost of purchase remains fixed. For ex: we have bought contract worth $5000 wherein the seller of the contract must sell the underlying commodity at $5000 which is the price agreed upon today at a future date as discussed by buyer and seller. Therefore the price won't change no matter what the price might be on the day of exchange, therefore this is a fixed price contract.

2)Yes, a fixed price contract can be hedged however by using options as a source to hedge our position at index respectively.

Ex: Investor brought a fixed price contract on futures on crude at $5000, however, he feels unsafe regarding the future price of crude, therefore he can buy a commodity option which he feels safe to hedge his position against the loss as he purchased the futures and want to hedge against the loss he can buy a PUT option by paying the premium, this acts like a insurance and if the position of futures drop below the strike price of the put option he may sell his contract and hedge against the loss.