8. Options, Futures and Other Derivatives Ch3: Hedging with Futures Part 2

[@tiarasingh957]

Hi, your videos are super good and still so relevant 5/6 years later! Please can you consider making more videos on the chapters after chapter 11? Your explanations enable a better understanding and grasp of the concepts, so would really like to continue using your videos after my course exceeds chapter 11 in the textbook. Please do consider it :)

[@ratnabalaji]

Hi Mark, at 13:00, shouldn't be "and we are going to realize the LOSS on the Futures contract" since we we agreed to buy for $2.20? I believe in the subsequent statements you mentioned that $.30 cents as loss on the contract. Please correct me if I am wrong. Thanks

[@ajkwqonfkasjd8419]

hello sir, this is great series! I am coming from comp science/maths background, at 11:43, the futures contract F1 (which we signed with some party in Jan) obligates us to sell the asset for 2.20$ at t2 which would of course benefit us as we will sell it at for 20 cents more than the spot price!, but instead we get rid of the futures contract and get the difference (F1 - F2 = 30 cents). My question is: how can we be sure that we will always be able to exchange/cancel our initial futures contract F1 and get the profit of F2 - F1 as the only obligation in this situation is for us to sell the asset for F1, i.e. where does this F1-F2 profit come from in real life and how does it work, how can we guarantee that we will be able to exit this contract obligation of selling or even worse, in scenario 2 when we have an obligation to buy at F1 and take losses due to delivery, storage and other costs?

[@MarkMeldrum]

Futures contracts are traded all the time. It is rather an easy matter to enter into an offsetting contract to cancel the first.

[@kdotchiu]

Hi Mark, I'm a bit confused in the last example (12:42) - if the f2 price is 1.90 (and assuming the future expires on t2), why can't we buy the futures contract, immediately settle and realise the gain of 0.1 (S2-F2)? Sorry if this is a dumb question. Thanks for the content!

[@MarkMeldrum]

The futures contract typically expires before the delivery date. So you can do that, wait for delivery, travel to the delivery place, pay for storage while you arrange shipping, pay for shipping to get it to your place. All the while waiting, the spot price may move against you such that it would have been far better to just buy in the spot market. Now, unless you need the underlying, you have the problem of having to sell it. Well you need a broker, you need to find a buyer, you may have to deliver it somewhere, you may even need several buyers to get rid of it, maybe not even at the price you paid. Rarely do long positions ever take delivery - it is very expensive to do so.

[@pratyushshakya679]

Hello, I just wanted to confirm that the last table you made with the short hedge and the strengthening basis is correct. Would the short hedger not be better off when the basis decreases because he is earning $2.3 instead of $2.2 when the basis goes from 0.3 at t1 to 0.1 at t2.

[@mohamedyoussef217]

Hi as I understand F2 = the settlement price of the future contract which is spot price of the underlying of asset at the expiration date, So (In other word) b2 means the variance between "spot price at delivery date for the soled asset" & the spot price of the hedged asset at the settlement date , which is meaning un-hedged part = basis risk

[@dharmendracs3138]

hello sir, as i asked in the other videos as well , at 11:53 why does the party sell at spot price 2.00 at (t2) when he has agreed to sell at futures price 2.20 as per futures contract ?

[@MarkMeldrum]

Most hedgers will close out their position and transact in the spot market. It can be costly an inconvenient to take or make delivery under the futures contract. The stuff does not just show up at your door. There are specific places for pick up and drop off that may be hundreds of miles away and require a fleet of trucks to get done.

[@yuzhouyuan6679]

Thank you so much for explaining!,particularly for the explanation of F1(It once made me so confused). I finally got some confidence on my derivatives course.

[@gauravkapoor111111]

sir, @10:35 what would F2 represent- futures price for the month of July itself or future price for the next period?

[@MarkMeldrum]

Its July.

[@gauravkapoor111111]

Thankyou sir

[@gauravkapoor111111]

Sir @12:05 is (F1-F2) payoff of Futures contract? Is it not (K-St)? getting confused here.

[@MarkMeldrum]

These are not options - these are futures contracts.

[@gauravkapoor111111]

so sorry made a blunder there. Thank you.

[@yicancu56]

Will we always know what basis risk will be? I can see how we would know Futures and Spot Prices, but will basis be shown also?

[@MarkMeldrum]

Basis risk can be determined based on the spot and futures prices.

[@yicancu56]

But wouldn't that be known after the fact? Would you know the futures price (F2) and spot price (S2) at the time of purchase?

[@brigittekudor9136]

Hi, big fan of the videos! So, I am getting confused a bit over the price of the futures. If we lock it in at T1, what do we mean by change in the futures price? Isn't that constant?

[@brigittekudor9136]

and also, the other thing which I am a bit confused about, is that when we have a futures contract, we will buy at T2 at the price agreed in T1, why do we buy/sell on the spot price? Thank you for your help in advance

[@OttoFazzl]

Futures prices change daily as result of market supply and demand. When you purchase a contract, the prices "fixes" for you, but not for the market.

[@fawzibriedj4441]

Hi, Thank you for this well explained lecture. I have a question that torments me ! Why the buyer needs to close his position ? He could have just waited for the delivery time and pay 2.20 instead of 2.30 when closing no ? Thank's in advance

[@MarkMeldrum]

Hedges are typically offset before delivery, in almost all cases. Delivery from a futures contract may not match your required time for delivery, it may be inconvenient to take delivery since delivery is done only at specific places (oil is in Cushing Oil, corn is in Toledo). That is why we introduce basis risk.

[@fawzibriedj4441]

Mark Meldrum It makes sense, thank you very much :)

[@hari02081025]

@10:42 to 10:49 I think it should be "if we are buyer then its bad and if we are seller then its good" because F1>S2

[@MarkMeldrum]

+hari prasad No - the spot price is lower. So if we are in the business of buying the asset, then that is good since we can buy it at a lower spot. However, if we are in the business of selling the asset, its bad since we now have to sell at a lower spot. This chapter is about hedging, so the only reason we would do that is if we have spot price exposure.

[@hari02081025]

+Mark Meldrum Ok my understanding is Future buyer (holding Long Position) booked the asset to buy at price F1 (at t1 when spot price=S1) and at contract expiration (t2) the spot price is S2 and S2S2, so the buyer has to pay more price that the spot price at expiration. At expiration the buyer is paying Price F1 rather than spot price S2. So that is how buyer is at loss at contract expiration i.e. (Loss= L1-S2) and i referred to this situation as bad for buyer. Please correct if my understanding is wrong. Thanks.