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Delivery risk and the hedging role of options

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  • Donald Lien
  • Kit Pong Wong

Abstract

Multiple delivery specifications exist on nearly all commodity futures contracts. Sellers typically are allowed to deliver any of several grades of the underlying commodity and at any of several locations. On the delivery day, the futures price as such needs not converge to the spot price of the par‐delivery grade at the par‐delivery location, thereby imposing an additional delivery risk on hedgers. This article derives the optimal hedging strategy for a risk‐averse hedger in the presence of delivery risk. In particular, it is shown that the hedger optimally uses options on futures for hedging purposes. This article provides a rationale 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

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  • Donald Lien & Kit Pong Wong, 2002. "Delivery risk and the hedging role of options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 22(4), pages 339-354, April.
    • Handle: RePEc:wly:jfutmk:v:22:y:2002:i:4:p:339-354
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    Cited by:

    1. Marin Bozic, 2010. "Pricing Options on Commodity Futures: The Role of Weather and Storage," Working Papers 1003, The Institute of Economics, Zagreb.
    2. Adam-Müller, Axel F. A. & Wong, Kit Pong, 2002. "The impact of delivery risk on optimal production and futures hedging," CoFE Discussion Papers 02/08, University of Konstanz, Center of Finance and Econometrics (CoFE).
    3. Udo Broll & Peter Welzel & Kit Wong, 2015. "Futures hedging with basis risk and expectation dependence," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 62(3), pages 213-221, September.

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