Answer-first summary for fast verification
Answer: Short 6,000 contracts
Because the company does **not** want to tail the hedge, use the standard optimal hedge ratio: \[ h^* = \rho \times \frac{\sigma_S}{\sigma_F} = 0.9 \times \frac{20\%}{30\%} = 0.6 \] Gold futures contract size is typically 100 ounces, so the number of contracts is: \[ N = 0.6 \times \frac{1{,}000{,}000}{100} = 6{,}000 \] Since the company is hedging a future sale, it should **short 6,000 contracts**.
Author: Manit Arora
Ultimate access to all questions.
Q-156.3 Rolling the hedge forward
A gold mining company employs a stack-and-roll hedge by rolling over near-dated contracts in order to hedge the gold price risk of a future sale in one year of one million ounces of gold. The spot and near-dated futures prices of gold, respectively, are $1,500 and $1,600. The volatility of spot price changes is 20%, and the volatility of futures price changes is 30%. The correlation between spot and futures price changes is 0.90. The company does not want to tail the hedge. What is the initial trade?
A
Short 5,625 contracts
B
Short 6,000 contracts
C
Short 12,655 contracts
D
Short 13,500 contracts
No comments yet.