MGRM Rollover Hedging?

[CanvasEcho]

Hi,

Could someone please elaborate on the roll-over hedging strategy used by MGRM.

I understand rolling over futures to mean
1. sell open position expiring in the current month
2. open new position that expires in the upcoming month
The net effect is postponement of the delivery a month in the future.

If that's the case, how would MGRM deliver the oil to the end-consumers at the end of the current month if there is no expiring future to cover the delivery?
Wouldn't they then be forced to buy the oil at spot to cover the delivery?

Thanks

 

[David Harper CFA FRM]

Hi @CanvasEcho MGRM Yes, that's correct. MGRM employed a stack-and-roll, as you (pretty much) show. But (to my knowledge) they never went to delivery in the futures market, which was their hedge. So, it was open the long stack, then next month "roll the stack" by closing that open position and opening a new stack (i.e., long new contracts); but there is a final close. So the idea is that physical delivery never happens in the futures market.

Rather, the cumulative gain (or loss) in the futures market is the hedge against the underlying purchase/sale in the spot market. Their hedge was a long stack and roll, so in theory it was hedging a spot price increase: it would profit to offset the higher future spot price. So yes, they did have exposure the the spot price. There is a bit more nuance because MGMR's underlying exposure were long-term forward contracts to deliver at the negotiated price, but it doesn't change that there are two things in parallel: (i) the underlying exposure and (ii) the stack in the futures market that never expects to see delivery and produces a cumulative gain/loss. I hope that's helpful,

 

[CanvasEcho]

Thanks David, that helped!