We focused on the 'futures' markets and how simple hedges can be accomplished using exchange-traded contracts. Here, we will address the 'over-the-counter,' non-exchange traded markets, or 'forward' contracts. Keep in mind that NYMEX Exchange contracts are referred to as futures' We will also cover financial 'spreads° whereby traders take advantage of price differences based on location, time, or inter-commodity relationships. Finally, we will deal with financial Options which are a simpler and less costly form of hedging vs. the financial derivative contracts themselves.
Key Learning Points - Energy Risk Hedging Using Swaps, Spreads and Options
• Exchange-traded energy contracts are known as 'futures' whereas non-exchange traded contracts are known as 'forwards."
• These are traded on electronic trading platforms or over the phone with licensed Brokers.
• 'Swaps are exchanges of payments between two parties. They are strictly financial. No physical exchange of the commodity takes place.
• One party to the transaction agrees to pay a current market price ('ked') while the other agrees to pay a price in the future ('floating').
• They are a simpler and less expensive way to hedge price risk.
• One very important Swap is a 'Basis Swap,' which is a market-determined value that represents the difference between the NYMEX Henry Hub contract delivery point for natural gas and other natural gas trading points in North America.
• Spreads are merely price differences between commodities that are interrelated somehow, have differing locations, or represent different months of the same commodity.
• They are traded for hedge purposes (reduce price risk) or outfight trading (speculate on price spread movement).
• Energy Options are yet another, more simple way to hedge price risk. They are less expensive than the outright purchase or sale of the underlying contracts. We will cover the types and their uses:
o Call Options
o Put Options
o Hedging with Options