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FRM Part I · FRM Exam Part I · Using Futures for Hedging

A jet fuel consumer plans to buy fuel in three months and hedges by going long heating oil futures because no jet fuel contract exists. Which statement best describes the main source of basis risk in this hedge?

The main source is that jet fuel and heating oil do not necessarily move together exactly. Because the hedged asset differs from the futures underlying, the basis can change unpredictably, leaving residual risk even though the futures converge to heating oil spot at expiry.

  1. AThe futures price must converge to the spot price of heating oil at expiry, which eliminates all risk
  2. BJet fuel and heating oil prices may not move one-for-one, so the asset being hedged differs from the asset underlying the contractCorrect
  3. CDaily margin settlement makes the futures price differ from the forward price
  4. DThe hedger is long futures, and long positions always carry more basis risk than short positions

Explanation

Cross-hedging uses a contract on a related but different asset, so the spot price of the exposure and the futures price can diverge unpredictably. Convergence applies only to the contract's own underlying, not to jet fuel. Margining and long/short direction are not the source of basis risk.

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