1. Devon Energy, a gas processing company, expects to pay for 400,000 mmBtu of natural gas at a close of day on Friday, February 1st. They want to hedge their position with Henry Hub natural gas futures. Assume that they enter into the position at close of day on Tuesday, January 29th. The size of one natural gas futures is 10,000 mmBtu. Futures and spot data are provided in the file HW1_data.doc.

1. Describe the position they should enter (long or short, contract month).

Because it is future purchase, so it is long

They should take the APR contract because it has the lowest traded price/exercise price

2. Compute the hedge ratio using data from Data_hw1.xls file.

The hedge ratio asked in the question is actually the optimal hedge ratio. The formula is (correlation coefficient of future vs spot price) * (standard deviation of spot / standard deviation of futures). We can copy the third table to excel and find the values using STDEV and CORREL functions.

hedge ratio = 0.829569*(0.097409/0.082654) = 0.977660 or 97.766%

We posted the excel document

3. How many contracts do they need to buy or sell?

Number of contracts needed = (optimal hedge ratio * total units)/units per contract

=0.977660*400,000/10000=39.1064 or 39 contracts

4. Document the price gain or loss every day that their position is open.

5. What is the total cost after they have closed out their futures position, and made their payment?

6. What is the effective cost per mmBtu?

Henry Hub Natural Gas Futures Data

Trade Date: Wednesday, 01/30/2019

Month	Open	High	Low	Last	Change	Settle	Estimated Volume	Prior Day Open Interest
MAR 19	2.909	2.919	2.846	2.872	-.049	2.854	96,441	316,538
APR 19	2.842	2.848	2.803	2.814	-.039	2.808	48,327	162,808
MAY 19	2.839	2.842	2.805	2.820	-.033	2.813	34,621	188,180
JUN 19	2.876	2.885	2.852	2.867	-.030	2.859	12,474	56,538
JLY 19	2.938	2.938	2.899	2.906	-.027	2.906	14,537	93,114
AUG 19	2.921	2.929	2.900	2.915	-.027	2.907	5,990	54,945

Trade Date: Friday, 02/01/2019

Month	Open	High	Low	Last	Change	Settle	Estimated Volume	Prior Day Open Interest
MAR 19	2.832	2.850	2.730	2.733	-.080	2.734	132,893	317,768
APR 19	2.789	2.792	2.695	2.696	-.066	2.699	70,612	159,095
MAY 19	2.787	2.792	2.704	2.707	-.063	2.709	58,575	190,826
JUN 19	2.829	2.837	2.750	2.751	-.064	2.754	24,934	56,901
JLY 19	2.886	2.886	2.794	2.796	-.066	2.799	19,543	93,941
AUG 19	2.875	2.883B	2.797	2.800	-.064	2.801	8,608	55,930

Spot Data:

2019/01/29 3.05

2019/01/30 2.95

2019/01/31 2.88

2019/02/01 2.86