Crude Oil Hedging - An Application of Currency Translated Options to Canada's Oil

Abstract

This study presents a review of pricing and hedging currency translated options. It is intended for Canadian Oil producers seeking to mitigate their production and F/X risks. Currency translated options are options based upon a foreign asset but with a payout that occurs in another currency. Different types of currency translated options are covered: Flexos, Compos or joint options and Quantos. A special emphasis is placed on the comparison between the first and the third versions of this product since the latter is the only version that completely eliminates the currency risk to the commodity/equity investor. Any oil producer or consumer can diversify its risks by transforming its complete dependence on spot oil prices into a variety of exposures to forward, futures, and options markets. In the light of these transformations, we analyze the efficiency of linearly delta hedging with Flexos and Quantos and further examine the hedging implications if any.