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| {{manual|DC|2005|Hedging Disruption|Section|Hedging Disruption|short}}On the topic of Commodities Index hedging disruption – nuanced because of the presence of regulator- or exchange-imposed position limits – the below language handles the position limits issue quite well: | | {{manual|DC|2005|Hedging Disruption|Section|Hedging Disruption|short}} |
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| One subtlety: because position limits apply to a trading book, or even across all trading books in a group, it is possible for the [[hedging disruption]] to be entirely unrelated to the specific hedge for the transaction. This is the reason for the Hedging Party’s discretion to determine which assets are counted towards the limit.
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| Note that this wouldn’t necessarily capture activity where the breach of position limits is caused by a change in option delta inside an existing index to which the business has exposure, as might happen where an index rebalances:
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| Example: say we have:
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| - A number of small delta 1 trades referencing WTI Crude
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| - A large net option delta on the S&P GSCI is large (i.e. we are long a large notional on the GSCI)
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| - We are hedging all these trades with WTI Crude futures such that across the whole book we are close to our position limit for WTI Crude.
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| - If the GSCI then rebalances to weight more heavily in favour of crude
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| Here our implied hedging position may take us over our Crude position limits, without there having been any active event to have precipitated this. Commodities futures roll monthly, so it isn’t as if we can grandfather the existing hedges.
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| There’s no “change in law”, as there’s been no change in the regulatory environment
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| it is only a hedging disruption if the provision allows it to “be within the sole and absolute discretion of the Hedging Party to determine which of the relevant assets or transactions are counted towards such limit” (i.e. the option delta of any given trade is below the position limit)
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| it may be an increased cost of hedging, because there are ways of hedging the risk – through derivatives which therefore using up someone else’s position limits, and that cost can fairly be attributed pro-rata across the whole book.
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| ====See also====
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| *{{eqderivprov|Triple cocktail}} - Equities
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| *{{commodprov|Triple cocktail}} - Commodities
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| {{commoddefanatomy}}
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