Suppose you are a natural gas seller, selling physical natural gas in the spot market to...

Suppose you are a natural gas seller, selling physical natural gas in the spot market to a pipeline in Henry Hub (which is the same location as the delivery of the natural gas futures contracts). You hedge by locking in $3.50 per MMBtu with a futures contract. How will the hedge work, if by maturity day spot price of natural gas is S_T?

		The pipeline will pay you $3.50 per MMBtu
		The pipeline will pay you S_t, and the futures exchange will pay you (3.50 - F_t), so hedge is not guaranteed to work
		The pipeline will pay you S_T, and the futures exchange will pay you (3.50 - S_T) due to convergence property, so hedge is guaranteed to work

Expert Solution

The answer is

The pipeline will pay you S_T, and the futures exchange will pay you (3.50 - S_T) due to convergence property, so hedge is guaranteed to work

The spot rate in future and forward rate equals due to convergence policy

The pipeline will pay the Spot rate, which the difference between forward selling price and spot rate will be paid by the exchange and hence, the hedge will work

as effective rate received will be $3.50 per MMBtu

jeff jeffy answered 2 years ago

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