Drlondoner
Essay title: Drlondoner
oil for delivery in ten years and the value of two different dated obligations do not move in lock step. In general, spot prices are more variable than the futures prices.
This is a feature that all hedgers must deal with. Hedgers in the futures market are “speculators on the basis,” trading greater price risk for a lessor basis risk. The basis risk is the difference between the price of the instrument and the price of the underlying asset being hedged.
A rolling stack of short-dated futures initially increases the variance of cash flows. This occurs because movements in the price of oil within the month create losses or gains on the entire stack of contracts.
These losses or gains must be settled by the end of the month; while compensating gains or losses on deliveries are realized only gradually over the remaining ten years of the delivery contract. When cash flows