Using our proprietary hedging platform , Hedge Insite , I ’ ve provided an illustration of the two margin scenarios . Hedge Insite provides a forward profit and loss system that takes the clients ’ sales and purchasing data , including any paper trades and wet barrels , and stresses their margin against price fluctuations in the futures market , including change in basis . It then takes this data and recalculates the various margin outcomes and condenses it into a single graph , allowing them to see with absolute clarity the impact their hedging activity has on their profits . This simple line graph illustrates an unlimited number of iterations ( typically 400 ) of their margin in both up and down markets .
In the example here , the green line maps out the put option strategy while the blue line maps out the call strategy . The green line ( the put option strategy ) exhibits the exact conditions described in the examples expressed above ; basis contracting with the put option strategy . Simultaneously , the blue line ( the call option strategy ) is exhibiting the basis blowing out with the call strategy . As you can see , each result in the exact opposite margin scenario .
The challenge here is how do you cover the basis blow out risk while also mitigating the risk of the basis contracting ? Both scenarios can have a serious negative impact on your margin if not hedged properly . There are tools in the marketplace you can obtain to mitigate both risks . The short answer is to deploy a mix of strategies . The traditional approach of buying wet barrels with put options is still a good strategy but should not be 100 % of your playbook . Equally so when using call options . Calendar spreads have been a great tool for hedging basis without taking on so called “ contraction ” risk . There is no perfect hedge in any scenario , which is why a blend of different hedges should be in everyone ’ s game plan .
Finally , when looking at your supply commitments overall , we have been advising our clients for years to consider having actual supply contracts with their suppliers . These are typically based on a transparent index such as Platts , Argus , or OPIS . They work very well when the basis is spiking , and they also get the peace of mind that comes with a commitment from their suppliers .
The information provided in this article is general commentary , for educational purposes . Please feel free to contact me with any questions . I can be reached at rlarkin @ hedgesolutions . com . Or visit www . hedgesolutions . com . l FON
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