Question

The spot price for gas today (March 19, 2020) is $1.661 MMBtu.  The futures price today for gas to be delivered in June 2021 is $2.245.  Your company is a gas purchaser/user and is interested in the hedging process.

1. You are a speculator and believe the price of gas will increase.  You have a chance to buy a June 2021 futures contract at $2.245.  Would you go short or go long on a June 2021 futures contract for 10,000 MMBtus?  

2. It is now December 31, 2020 On this day, the spot price for natural gas is $2.450 per MMBtu and the June 2021 futures price is $2.310 per MMBtu.  What is the amount of gain or loss related to your contract as of December 31, 2020?

3. As a speculator the last thing you want to do is either take delivery of or actually sell natural gas.  Explain how you would get out of the contract you purchased in part e. prior to the June 2021 delivery date.

Answer 1

Note: In the first para it is given that customer is interested in Hedging process , hence all answers are given accordingly as hedging and not speculation.

Answer 1: As there is belief that the price of gas will increase, the company will take long position on gas for June 21, i.e. it will purchase 10000 June 21 futures for gas on March 19,2020 @ 2.245. The reason for this is that if the belief of price rise continues on the exercise date the price of gas will be more than its futures price and hence company will be able to purchase gas at lower prices.

Answer 2: For Calculating gain/loss at year end, future prices are to be compared, spot price has no relevance. The June future price of gas on December 20 is 2.31 i.e. higher from when the company purchased @ 2.245. Hence there is a gain of $650 [10000 MMBtu *($2.31-$2.245)]. It will recorded in the books of accoounts on December 20 as futures gain.

Answer 3: In order to get out of Long position before June 21, the company has to reverse its position i.e. sell/short 10000 June 21 futures. If the company keeps the position on delivery date, it has to compulsorily exercise the option.