Monthly Archives: September 2012

¿Prepare for the bad, close your eyes to the worst?

Javier Blas at the Financial Times reports on the Mexican state’s new strategy for hedging the oil price. In recent years, the state had bought puts. But in the last couple of years, those puts expired out of the money. Whenever that happens, people start second guessing a strategy. The premium paid begins to look expensive. So this year the Mexican state has found a way to save on the premium. Instead of buying a simple put with an exercise price in the range of $80-85/barrel, it is buying a put spread with a second strike price around $60/barrel. If the price drops below the first strike around $85, then the put begins to payoff. But below the second strike of $60/barrel, the gains on the put are capped. The cost of the simple put on approximately $200 million barrels is said to be in the neighborhood of $1-1.5 billion. Using the put spread, the costs are halved, according to the Financial Times.

Of course, the cost is less because the Mexican state is buying less insurance. What is odd is that it is foregoing insurance exactly when the state will be in direst need.

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