Assume that oil is trading for $50 per barrel today. The oil price can go down by 33% or up by 50% per year. That is, it can sell for either $33.33 or $75.
(a) You own a refinery. It is worth more if the oil price is higher. Intuitively, what kind of oil transaction would reduce your risk?
(b) Your refinery can produce profits of $1.5 million if oil trades for $33.33, and profits of $3 million if it trades for $75. If you write a contract to sell 30,000 barrels of oil for $50/barrel next year, how would your risk exposure change?
(c) If you want to be fully hedged, how many barrels of oil should you be selling?