J l and hedge essay

1 ) J & L are able to use heating olive oil futures to hedge its exposure to diesel fuel rates. Which futures and options position will need to J & L consider? Explain.

J&L Railroad should take a long situation. They need to buy diesel gas in the future, they don’t create diesel energy, so they will want to take an upcoming to be able to lock in the price of diesel fuel for future purchases.

2 . What problems is the use of warming oil futures for hedging create for J&L? Take note: I assume this kind of question is asking regarding heating oil specifically certainly not futures generally.

As heating system oil can be not the same merchandise as diesel powered fuel, consequently there could still be some direct exposure (risk) pertaining to J&L. There has been a historical correlation among heating essential oil prices and diesel gasoline prices, nevertheless this might certainly not be authentic for the future.

The futures pertaining to heating oil are legal agreements for delivery of 40, 000 gallons ” how much diesel energy needed in different month is definitely unlikely to equal 40, 000 gallons or a multiple of that sum.

Since the warming oil futures and options mature on the last working day of the earlier month and then the purchase would have to occur about that day.

3. Make clear why the daily pay out of options contracts contracts can easily create cash-flow problems to get J&L?

In the event that J&L purchases a long long term contract, they have to provide the primary margin for every single contract. In case the price of heating essential oil goes down (even for a brief period) to get the margin to below the maintenance margin, J&L can be required to leading up the margin to the primary margin amount. If they don’t have the ready cash to do this their futures deal would be cancelled.

This could need J&L to take care of a substantial amount of cash or the accessibility to a personal credit line they can attract on, while needed. The costs to hold that much cash and also the interest on a line of credit may well exceed the value of the hedge of diesel powered fuel rates.

As the contract hasn’t closed however (and it may be a while until it finally does with regards to the length of the contract) these daily settlements may affect the temporary cash requires of the organization.

If the value goes up there is not an issue with cash requirements (other than the initially necessary margin).

some. How do choices on futures work? So why can trading options on futures may be preferable than trading choices on the physical heating olive oil? An option over a future may be the ability to choose the future (or sell the future) at a given selling price. If the long term doesn’t reach that selling price, you don’t have to purchase it. An amount called a premium is billed for the options.

If instead of trading options on a future, J&L may trade options on warming oil. Doing exercises an option over a future simply requires the cash margin to be deposited, working out an option in heating oil would require the total benefit of the heat oil work out price to paid.

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