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Interest rate risk in long‐dated commodity options positions: To hedge or not to hedge?

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  • Benjamin Cheng
  • Christina Sklibosios Nikitopoulos
  • Erik Schlögl

Abstract

We empirically assess hedging interest rate risk beyond the conventional delta, gamma, and vega hedges in long‐dated crude oil options positions. Using factor hedging in a model featuring stochastic interest rates and stochastic volatility, interest rate hedges consistently provide an improvement beyond delta, gamma, and vega hedges. Under high interest rate volatility and/or when a rolling hedge is used, combining interest rate and delta hedging improves performance by up to four percentage points over the common hedges of gamma and/or vega. Thus, contrary to common practice, hedging interest rate risk should have priority over these “second‐order” hedges.

Suggested Citation

  • Benjamin Cheng & Christina Sklibosios Nikitopoulos & Erik Schlögl, 2019. "Interest rate risk in long‐dated commodity options positions: To hedge or not to hedge?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(1), pages 109-127, January.
    • Handle: RePEc:wly:jfutmk:v:39:y:2019:i:1:p:109-127
    DOI: 10.1002/fut.21954
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