|Title: Delivery Risk and the Hedging Role of Option|
|Reference Number: 1033|
|Publication Date: October 2001|
|JEL Classifcation: D81, G11|
| Author(s): |
University of Texas
Kit Pong Wong
The University of Hong Kong
Multiple delivery specifications exist on nearly all commodity futures contracts. Sellers are typically allowed to deliver any of several grades of the underlying commodity and at any of several locations. On the delivery day, the futures price as such needs not converge to the spot price of the par-delivery grade at the par-delivery location, thereby imposing an additional delivery risk on hedgers. This paper derives the optimal hedging strategy for a risk-averse hedger in the presence of delivery risk. In particular, it is shown that the hedger optimally uses options on futures for hedging purposes. This paper provides a rationale for the hedging role of options when futures markets allow for multiple delivery specifications.
Published in Journal of Futures Market 22:4, Aug 2002, pp. 339-354.
Key words: Futures, Options, Multiple delivery specifications
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