I am a part of the team which is responsible for management and hedging of commodities exposures. Some say corporates are good only in following advice from banks or brokerages. I do agree corporates do not have market insight of a bank. But here is a problem. It is not bank or broker or a hedge fund that has biggest risk that markets will go against them. These guys always have an option to do nothing and wait for a better trading opportunity where as we don't. We have to continue to purchase commodities, spend currencies for daily business. Such company is always exposed to changes to market price even if it decides not to hedge. In fact my company has probably one of the biggest short commodities portfolio in the world. Managing such risk effectively is a challenge. It is like being between a rock and a hard place. You get your behind kicked all the time be senior management, whether it was a missed opportunity to hedge or hedge that turned to be out of the money. Critics will say if you lost money on your hedge then you probably bought it cheaper on physical market. let's face it, nobody wants to loose money, full-stop.

So I do not have an option to do nothing as I am always in the position (short in this case). I think people like me have higher motivation to earn positive return on their portfolio then other players. In fact my intention is to bring hedging to a performance benchmark of proprietary trading.

Search This Blog

Thursday, May 6, 2010

How do you price uncertainty?

Coincidently I decided to start writing this blog the day before markets collapsed. And this is big for me since last time I wrote something bigger then an email was five years ago in the university.

Next day markets dropped on good economic news and something we new already for quite some time but chose to ignore. Why was market reaction different this time? The answer is as old as the market - fear itself. Assets that were linked to a macro story that developed over the last two years got hit the worst: forex, equities and commodities. The exception was US natural gas that nobody likes but it is one of few commodities that trades according to its fundamentals.

I said before that I was not going to make economic forecasts as there are people with experience and resources to do that. So here is a question to forecasters. How do you incorporate uncertainty into your forecasts? How can you be sure of supply - demand balance forecast for commodities? Constant need to have a view on the market makes it is almost impossible. Therefore you have people making price forecasts as close to forward curve as possible. And that's why you cannot make hedges based on these forecast as most probably they will be wrong. You need flexibility to be able to get in and get out of your position given the market conditions and not forecasts.
Posted by at

No comments:

Post a Comment

Subscribe to: Post Comments (Atom)