Question

Which of the following are hedging strategies on a commodity for a company which uses the commodity as an input for their production (i.e. they are a buyer of the commodity)? For each of the strategies below, indicate with either a “Yes” if it is a hedging strategy for the buyer or a “No” if it is not a hedging strategy for the buyer. Also, provide an brief explanation for why you’ve selected either a “Yes” or a “No” for each strategy.

i. Selling a call on the commodity

ii. Buying a collar position on the commodity

iii. Buying a call on the commodity

iv. Selling a forward on the commodity

v. A short futures on the commodity

Answer 1

(i) Selling a call on the commodity

No.

Selling a call option will be profitable only if the exercise price of the commodity is above the option strike price. In this case, the buyer will have a loss

(ii) Buying a collar position on the commodity

Yes.

A collar involves simultaneously buying a call and selling a put at a higher strike price. This locks in the net purchase price of the commodity, and hedges against a rise in the price of commodity

(iii) Buying a call on the commodity

Yes.

A call option will be profitable if the rise in value of the commodity. This will also offset the gain on the put option , thus hedging the net purchase price

(iv) . Selling a forward on the commodity

No.

If the forward is sold, there will be a loss if there is an increase in the price of commodity. Thus it does not hedge the net purchase price

(v)  

A short futures on the commodity

No.

If the futures is sold, there will be a loss if there is an increase in the commodity price. This does not hedge the net purchase price