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Answer: If the oil futures curve shifts to backwardation, the futures trades by themselves will necessarily produce a loss
The question asks for the **EXCEPT** statement, meaning the one that is **not** a weakness. - **A** is a weakness: daily marking-to-market can create timing mismatches. - **B** is a weakness: rolling futures does not guarantee enough profit to offset the spot loss. - **D** is true: profits can exceed the spot loss, creating an overhedge gain. - **C** is false because backwardation does **not necessarily** produce a loss for the futures trades; in fact, it may improve the hedge through positive roll yield. So the exception is **C**.
Author: Manit Arora
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Q-156.5 Rolling the hedge forward
Assume an oil producer employs a stack-and-roll hedge against the anticipated sale of a large quantity of oil in 16 months. At the start of the strategy, the spot price of oil is $105; at the end of the strategy, 16 months later, the spot price is $80. Throughout the hedge, futures prices are greater than spot prices such that contango persists. EACH of the following is a potential weakness (or imperfection) of "rolling forward" near-dated oil futures contract each month EXCEPT for:
A
Daily settlement of futures contracts can cause a timing mismatch between the cash flows of the hedge and the underlying price exposure
B
The stack-and-roll futures trades, by themselves, will not necessarily produce at least a profit to offset the spot price drop
C
If the oil futures curve shifts to backwardation, the futures trades by themselves will necessarily produce a loss
D
It is possible for profits on the future trades to exceed the underlying spot loss of $25; i.e., an “overhedge” gain is possible
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