Question

Scenario: Suppose you are a risk management professional working for risk managing firm which islocated in Dubai. risk managing firm provides consulting services to firms such as airlinecompanies and mining companies on their risk management. Mr. Abdul, the treasurer of goil Pte Ltd, approaches you today (assume it is now July 2020) to ask you for advice onthe financial risk management of his company. Goil (Dubai) Pte Ltd is a trading company which specializes in international trade of petrochemicals and petrochemical equipment. In recent years, Goil mainly deals in crudeoil, gasoil, diesel oil and fuel oil, with plans to increase its size and valuation over the next few years. Goil is a growth company that aims to a growing cash flow from expanding oiltrading operations. As a growth company, Gemoil’s revenue is positively related to oil priceand it aims to a growing cash flow from expanding oil trading operations and seeking to define up to 20 million gallons of jet fuel in December. The company’s profit and loss are subject to many risk factors, such as the price change of oiland foreign exchange rate fluctuations. As the market price of oil is quite volatile, thecompany is considering using some strategies to manage its risk exposure. One way to hedgethese exposures is to use futures contracts. For instance, the futures contracts traded in the NYMEX.

How many heating oil futures contracts should be traded in order to achieveoptimal hedging? (Assuming with tailing adjustment)3) Please devise a hedging strategy for Goil:

Answer 1

In this case, the risk for Goil company is the fluctuating oil prices and mainly if prices of oil goes down than company might incur less profit or even in certain cases loss as it is clearly mentioned in the question that company's revenue are positively correlated to oil price means if price goes up more profit and viceaversa.
Considering the scenario of company expanding oil trading operations and seeking to define up to 20 million gallons of jet fuel in December, as a hedge to the risk the contract size of HEATING OIL FUTURES ON NYMEX EXCHANGE IS 42000 GALLONS so company can short 476 lots of heating oil futures of Heating oil for hedging risk of oil prices going down.
The figure of 476 lots is found as under :
20 million gallons to be processed divided by 42000 gallons lot size of heating oil futures = 476.19 so rouding off nearest rounded figure comes is 476 lots
The outcome is that the company has locked in price of its to be traded value of 20 million gallons in December by shorting heating oil futures in nymex exchage worth 20 million gallons (476 lots) so if the price of futures goes down company can offset its to be traded 20million gallons by gaining profits in shorted heating oil futures and if price of heating oil futures goes up than company can incur profits by selling 20million gallons at higher price but the gains will be offset by losses in position of shorted heating oil futures.
This way Mr. Abdul, the treasurer of goil Pte Ltd is advised to short 476 lots of heating oil futures in nymex as a part of hedging strategy.