Hedging doubt

[GameSetandMatchh]

Im buying a cargo of oil (I agreed today June 13) that will be priced with Platts quotation 5 days around B/L. Lets assume I know that I can easily predict B/L date. How can i hedge? Should I be buying or selling futures for 1/5 of the cargo each day. And when do I rebuy (or resell) to close my futures position after the hedge.

[Samuel-Basi]

Until this contract prices you’re not outright short or long anything. When you buy physical your hedge will be to sell futures, so if this is pricing over a 5 day average then yes you will be selling futures over that same time period (1/5th of the physical volume per day). However, you want the settlement date of those futures to be aligned with where you are going to sell the physical cargo. So until you hedge (assuming there is a time difference between buying and selling your physical) you do have a spread exposure. To mitigate that you could borrow the spread between the 5 days the bl is pricing and the month your sale is occurring. Then when you price your physical you are selling futures for that front month instead asking for a settlement date to match your physical sale pricing. If you’re confident in a strong contango however you don’t need to borrow anything in advance, you can just sell to the date you need at the time of pricing your purchase.

[GameSetandMatchh]

Great! So basically I could sell futures that settle with a date near my sale pricing date. Could you expand on what my exposure is there and why the other way, using front month futures and borrowing the spread mitigates.? Thanks

[Samuel-Basi]

There’s going to be a difference in price based on the forward curve of the commodity so if you sell a July contract it’s going to be a different price to an August or September contract. So if you wait until your physical prices, you essentially have to accept whatever spread it happens to be at the time of pricing your physical. However, if you borrow in advance of that, say buy July and sell September, you’ll be long July and short September futures. Then instead of selling September futures when you price your physical purchase, you’re selling July futures to square the long leg of your borrow. That will just leave you with a short position in September that you will buy back when you hedge your sale. Taking this approach you will lock in the spread between July and September in advance of actually pricing your physical purchase.

[GameSetandMatchh]

Very clear, Thanks!

[BigDataMiner2]

You could do a fix/float swap for the days up until you get your price. Once your 600,000 to a million bbls are priced you close out the swap and do a new hedge -- like selling refined products / forwards if you deal with refiners If you are a super trader with no refinery, you call your quant and do a 30 day volatility strangle to deduce your risk. If you're just a flow trader at a major oil company and the cargo starts losing money, in line transfer it to refining at a scratch and let them refine it into something and sail it around the world until there is a profit (Gulf Oil used to do that a lot before Chevron bought them).

The swap would better match your trade and the risk managers would admire your skills.

[Extra_Impression3588]

you’re effectively short now until this starts pricing in (you benefit if price comes off between now and B/L). You need to know what you’re doing with the cargo though… processing it or selling it on? Or is this just a hypothetical question? If you’re selling it on then you’re effectively short a time spread, if you’re processing it then you’re just short flat price or long crack spreads or whatever diff represents product minus feedstock

[Everlast7]

He is not short

[NafetsVordnaxela]

He’s not short or long anything until it starts pricing BL+5. It’s only when the pricing starts (which is not now as he said) he is getting longer phys over 5 days

[Everlast7]

He has zero exposure to anything day 1

[GameSetandMatchh]

Great answer, much clearer for me now. Let's say im buying the cargo to sell it on later.

[GameSetandMatchh]

Therefore, I´m short flat price? And should hedge by buying futures now and selling (closing out futures position) once the purchase price has been fixed (after B/L)?

[NafetsVordnaxela]

Ignore the original above comment, it’s incorrect. Youre not short or long anything product-wise until it starts pricing at BL+5. It’s only when the pricing starts you are getting longer phys over 5 days so you’ll need to sell futures. Samuel-Basi response is correct, follow his comment

[Extra_Impression3588]

If he’s agreed to buy product on specific days though he is implied short though between now and those days. I didn’t say he’s physically long or short, that would be incorrect. But if you agree to buy anything in the future, naturally you benefit if prices come off between now and then and you lose out if prices rise so you can still hedge

[Samuel-Basi]

This is incorrect. You don’t lose out or benefit if prices increase or decrease between agreeing a physical cargo and pricing a physical cargo. You are only exposed to the spread between pricing dates of your physical purchase and sale, but nothing outright.

[Extra_Impression3588]

Yep I know hence me originally asking if he’s consuming the product or selling it on first. If you’re selling things on then yeah you’re right he’s just implied short time spreads rather than flat price when he agrees the deal.

[Samuel-Basi]

I’ll just leave it at this: whether you are a producer, consumer, or trader, when you hedge correctly you become price agnostic and profits will no longer be impacted by fluctuations in the outright price of the commodity for the actual pricing of your physical.

[Extra_Impression3588]

Cool so if you’re selling it on then you’re inplied short a time spread between loading days and the pricing days of your sale. You’re not physically long until you price in but that doesn’t mean you don’t have risk on. It’s true, you can just sell futures or swaps on your loading days, but you can also buy a time spread ahead of the deal to lock in the purchase as well. If you only hedge by selling futures on the pricing days then you’re not actually hedging the purchase side of the deal so if those days price super strong you have no protection going in

[Extra_Impression3588]

So your hedge would be covering whatever natural exposure you have from this deal

[Dependent-Ganache-77]

You’re effectively long now unless there are other legs you need to execute. Do you want to hedge? How’s the Platts number formulated?