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Delivery risk and the hedging role of options
Author(s) -
Lien Donald,
Wong Kit Pong
Publication year - 2002
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10011
Subject(s) - futures contract , commodity , economics , financial economics , microeconomics , actuarial science , risk analysis (engineering) , business , finance
Multiple delivery specifications exist on nearly all commodity futures contracts. Sellers typically areallowed to deliver any of several grades of the underlying commodity and at any of several locations. On thedelivery day, the futures price as such needs not converge to the spot price of the par‐delivery grade atthe par‐delivery location, thereby imposing an additional delivery risk on hedgers. This article derivesthe optimal hedging strategy for a risk‐averse hedger in the presence of delivery risk. In particular, itis shown that the hedger optimally uses options on futures for hedging purposes. This article provides arationale for the hedging role of options when futures markets allow for multiple delivery specifications.© 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:339–354, 2002