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An airline expects to SELL one million gallons of jet fuel in one month and decides to use heating oil futures for hedging. We suppose the correlation between jet fuel price and heating oil price is 0.93, the volatility of heating oil price is 0.03, the volatility of jet fuel oil price is 0.02. Each heating oil futures contract allows you to trade 42,000 gallons of heating oil. How many contracts should be used in hedging

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Answer:

14 contracts should be used in hedging.

Explanation:

The heating oil price is 0.93

The volatility of heating oil price is 0.03,

The volatility of jet fuel oil price is 0.02

Determining Minimum variance ratio

0.93×0.02/0.03 = 0.62

Each heating oil futures contract trade is 42,000 gallons of heating

ThereforeThe optimal number of contract is :

O.62×1,000,000/ 42,000 = 14.76

Converting 14.65 to nearest whole number will give us 14

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