Question

You are an oil producer and you believe that oil prices are so insane these days they ought to decline in the medium- to long-run. You see a December light sweet crude futures settling at $109 a barrel. The contracts are for 1000 barrels each. You decide to hedge 10,000 barrels of your reserves with this futures contract.

a. Under each of the following scenarios, show the value of your futures position, the value of your oil position, and the total portfolio value on the maturity day. Please analyze each of your positions in this problem individually, i.e. as if the other position did not exist; and then simply add up the values of the two positions to get the total value under each scenario.

	Maturity Day Spot Oil Price, $$ per bbl
	100	109	120
Value of your position in the futures
Value of your position in oil
TOTAL

b. If you close out your futures position prior to the contract maturity day, the hedge is not guaranteed to work. (True / False)

c. If you close out your futures position prior to the contract maturity day, your futures account will not be marked to market. (True / False)

Answer 1

a)

Maturity Day Spot Oil Price, $$ per bbl
	100	109	120
Value of your position in the futures	$ 1,090,000.00	$ 1,090,000.00	$ 1,090,000.00
Value of your position in oil	$-1,000,000.00	$-1,090,000.00	$-1,200,000.00
TOTAL	$      90,000.00	$                 -	$ -110,000.00

b) True as the position may be closed at some other price

c) False, future contract is marked to market each day.