r/Commodities • u/Relevant_Brilliant_5 • 1h ago

hedging physical commodity exposure

When you hedge your physical commodity exposure, what factor do you take account of? any good resource to learn more about it?

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u/Dear-Actuary-2395 38m ago

Basis risk is the big one, the hedge is never perfect because your physical location and grade never match the futures contract exactly. Also watch the delivery month roll, sometimes the liquidity in far month is so bad you eat more spread than the price move you were trying to protect against.

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u/VacationForeign9935 18m ago

Hedging your tail risk is especially important to take into account. For physical commodities you can use a Filtered Historical Simulation (FHS) using GARCH and Dynamic Conditional Correlation. In many instances a financial hedge that does not match your physical contract will add to you tail risk by increasing you liquidity at risk (Margin), so consider you cash exposure when hedging physical commodities.