Guidebook for Evaluating Fuel Purchasing Strategies for Public Transit Agencies (2012) / Chapter Skim
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Pages 23-34
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From page 23... ...
23 Hedging with Cap-Price Instruments Cap-price instruments create a price ceiling that prevents fuel prices from exceeding a certain level. They are often compared to insurance: the buyer pays a premium in exchange for protection against a bad outcome.
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24 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies are further classified based on whether the option is being bought or sold. A full explanation of the different types of options available to transit agencies is beyond the scope of this overview.
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Hedging with cap-Price instruments 25 Source: SAIC Time Unit Figure 4.1. Cap: gains and losses versus hypothetical market (spot)
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26 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Options Pricing, cont'd Source: SAIC, OptionTradinngTips.com: http://www.optiontradingtips.com/pricing/free-spreadsheet.html "At-the-money": Strike Price = Spot Price at Initiation Figure 4.2. Twelve-month European-style call option premiums by strike price when spot price is $2.50, interest rate is 5%, and volatility is 15%.
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Hedging with cap-Price instruments 27 Source: SAIC Market Price Cap Price Floor Price Agency Price $1.50 $1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25 $3.50 10 11 12 13 14 15 16 17 18 19 1 2 3 4 5 6 7 8 9 20 21 22 23 24 Gains versus market price Losses versus market price Time Unit Figure 4.4. No-cost collar: gains and losses versus hypothetical market (spot)
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28 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies 4.1.3 Participating Cap A participating cap is similar to a collar in that both strategies offer ceilings on upward price movements and trade away some benefits from falling prices in order to reduce or eliminate premium costs. Rather than employing a firm price floor like a collar strategy, a participating cap trades away a percentage of every downward price decline.
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Hedging with cap-Price instruments 29 strategy does not give full protection under extreme price scenarios. Figure 4.6 shows how the price corridor would perform versus the market over a 24-month period given a hypothetical range of market prices.
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30 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Hedging with options avoids adverse basis risk (see Info Box: Basis Risk) , even if the options used are based on a price index that does not always closely track local prices.
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Hedging with cap-Price instruments 31 programs over other, unnamed programs. Rather, the purpose of this discussion is to provide a better understanding of how these types of programs work and provide examples of the ways in which they differ.
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32 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies possible to extend coverage to any number of consumers regardless of volume. Although this type of protection is similar in nature to insurance, the web-based programs are not insurance products.
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Hedging with cap-Price instruments 33 4.2.1 Advantages Web-based fuel price protection programs that offer cap-price protection share some of the same advantages as purchased call options (caps)
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34 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies hedging with web-based programs are extremely high relative to hedging with other tools, such as OTC swap or futures contracts. The premiums, which are paid up front to Pricelock and Fuel Bank, can be prohibitively high for a small, cash-strapped transit agency.
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