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# Stack and roll hedge

#### wrongsaidfred

##### Member
Hi David,

The basic idea of a stack and roll makes sense when the market is in normal backwardation. Getting long contracts that are two or three months out, riding the curve up and re-establishing. What I cannot wrap my head around is a statement in McDonald concerning the stack and roll.

"You might decide that the forward curve looks unusally steep in the early months. If you undertake a stack hedge and the forward curve then flattens, you will have locked in all of your oil at the relatively cheap near term price, and implicitly made gains from not having locked in the relatively high strip prices."

The first thing is, when he says "the curve flattens" does he have have to specify about which end it is pivoting? It seems a little arbitrary. In this case, I assume this means that the VERY near term does not move at all and the curve "pivots" around this near term price so that longer term forward prices come closer to approaching short term prices.

This might be getting a little overly technical, but if the forward market is in backwardation, pivots around the short end and then inverts, would this be considered a steepening as is goes further into contango? In other words, does the jargon apply so that "flattening" always means just approaching horizontal or can it mean something else?

Second, I do not see how this would mean that he saves money by not locking in the expensive strip prices. If a curve is in backwardation and flattens out (especially around the short term end of the curve) it seems like long term forward prices would be getting more expensive and that he would have been better off getting the strip.

Any clarification you could provide would be greatly appreciated.

Thanks,
Mike

#### David Harper CFA FRM

##### David Harper CFA FRM
Staff member
Subscriber
Hi Mike,

This also has been argued over (I can't find earlier links, I am in a rush right now trying to get through all of your forum questions so i can make some product!), my current interpretation is that McDonald is simply imprecise. Thoughts:

* Flattening is just a reference to slope. I think he means here, that the spot is roughly maintained while the forward prices are coming down, but there are several permutations of flattening (e.g., both spot and forward can move down)
* By "implicit" he (IMO) implies an opportunity cost (gain): instead of promising to pay at a higher future price, we waited to promise to pay at a less higher price. We don't typically commingle this sort of opportunity cost/gain concept into the return calcs
* He is coming from a discussion where the oil producer is SHORTing futures, in which case, the roll return profits on contango (we typically say profit on backwardation b/c we are referring to long futures), so i think he's assuming something there
* His isn't parsing the components of futures return (it isn't just the roll return; it's the spot return, too).

In summary, i am sort of where you on this statement, I have tried to visualize his exact meaning but i get a little stuck in the imprecisions and i think it's possible he simply means a sort of blunt opportunity cost. Thanks, David

#### wrongsaidfred

##### Member
You are the best!

Thank you for taking the time to answer all of my questions.

Mike

#### wrongsaidfred

##### Member
Hi David,

I did not want to start another thread to ask you about this, but I was wondering if you had time to look over a few questions I fired at you last week that you never got around to answering. I know that you are really busy and you have already spent A LOT of time answering my questions, but they were all on the same day or two so they have have gotten lost in the shuffle. I think they were from last Monday and Tuesday.

If it would make things easier for you, I could re-post them in one message, or if they were not good forum questions I could try and do some research on my own.

Thanks,
Mike

#### David Harper CFA FRM

##### David Harper CFA FRM
Staff member
Subscriber
Hi Mike,

I'll take a look when i can, please don't re-post. The forum is "best efforts," not a guarantee i will answer every question. You've asked like 60 or 80 (?) questions in ONE MONTH, i think, and in all seriousness I can't afford to neglect the rest of the business to support one customer. If you think about the price of the product, you'll see why this is greatly unprofitable for us. We are actually looking into limiting the questions or charging extra because i can't cope with one customer asking 60 or 80 questions in a month. (we have other customers, right?)

Don't get me wrong you ask great questions, but at the same time $249 does not earn you my daily accountability to your questions (we would go out of business under that plan) under any reasonable test. Thanks for understanding, David #### wrongsaidfred ##### Member Hi David, My appologies for my last email. My purpose was certainly not to insinuate that you owed me anything. You have been more than patient with my questions and I truly do appreciate your efforts. Sincerely, Mike #### David Harper CFA FRM ##### David Harper CFA FRM Staff member Subscriber Mike, Thank for your understanding, I will try to get to them. David #### BoobyMiles ##### New Member I agree with Mike. you've been truly great throughout this process. One "make-greater" suggestion i wanted to bring up, especially given how stretched you are across the business, answering client questions tremendously well while also generating updated content continuously, is as follows: Have you looked into outsourcing a "layout and design" team or individual that could revamp all your materials to replace calculations like " sqrt(r+var.^2/2)/[var.(sqrt(t)]" with a more visually-comprehensible picture/layout ? I know its not a small feat, but this is why i bring it up. I did the entire Schweser FRM prep in tandem with yours. Now, there summaries were decent, but did not nearly prepare students adequately enough for the actual material and wholistic approach the exam tests students on. your material very much did. I did only all your end of chapter question sets, your end of chapter quizzes, and your 7 mock exams. I did each of them twice, and i'm confident that 75% of the points i scooped on exam day were wholly attributable to this practice, not to reading schweser condensed summaries which skipped a lot content. the only drawbakcs were two fold: the notation mentioned above, which for harder calculation problems (eg. finding updated correlation given GARCH(1,1) omegas, vols and two stock returns), was in all honesty a nightmare. What should have taken two repeats of the problem to get "locked-down" took upwards of 30minutes, most of the time spent simply trying to connect which number matched which, and what was the crisp formula at each step the second and last drawback from BT to Schweser (and please believe me that if given the choice to only use one service, it would be BT so i mean this with the best of intentions). the last drawback was the missing explanations in a lot of the questions. even in the forum discussion, you had to parse through individuals questions, often discussing a particularly part of the question that students looking for an explanation may not be confused about. for the "find updated correalation given GARCh (1,1) inputs", the answer was actually only answered by a former student. similarly to the above, perhaps outsourcing a former student to go through each forum answers for all the questions and create a single, coherent, explanation/solution in the BT materials would be more than worth the time and resources spent. both these are time-consuming tasks, and i know you must be swamped. i truly think these two simple (yet arduous) improvements to the service would launch it from a more boutique FRM review course into the hands-down, no-question-about-it, premiere provider of FRM review. "If you want the letters, you need the Turtle" thanks for reading this essay of an reply! i was thinking this throughout my review and just had to speak up (the whole study period i was thinking "wow, this is amazing stuff, if BT somehow improved its formatting and added crisp answers, schweser's FRM review course would be out-of-the market within two test cycles. Last edited: #### David Harper CFA FRM ##### David Harper CFA FRM Staff member Subscriber Hi @BoobyMiles Thank you for the feedback. (cc @Nicole Seaman). Question for you: your last sentence reads "if they somehow improved this formatting and added crisp answers, schweser's FRM review course would be out-of-the market within two test cycles." but I assume that you mean Bionic Turtle? Sorry, we just don't want to edit your message .... if you can edit, we'd be grateful. In regard to your two items: 1. I absolutely agree that "proper" notation would be an improvement. As you say, it's just a time consuming endeavor (we do have limited resources) 2. I also agree with this suggestion, and for selected questions, I think we should do it. It's all just an issue of where we can spend limited time. Thank you again! #### Karim_B ##### Active Member Subscriber Hi @BoobyMiles Thank you for the feedback. (cc @Nicole Seaman). Question for you: your last sentence reads "if they somehow improved this formatting and added crisp answers, schweser's FRM review course would be out-of-the market within two test cycles." but I assume that you mean Bionic Turtle? Sorry, we just don't want to edit your message .... if you can edit, we'd be grateful. In regard to your two items: 1. I absolutely agree that "proper" notation would be an improvement. As you say, it's just a time consuming endeavor (we do have limited resources) 2. I also agree with this suggestion, and for selected questions, I think we should do it. It's all just an issue of where we can spend limited time. Thank you again! Hi @David Harper CFA FRM I think @BoobyMiles is saying you'd crush the competition within 2 test cycles Let's see if I read it right when he confirms. Best Karim #### David Harper CFA FRM ##### David Harper CFA FRM Staff member Subscriber @Karim_B ohhhh geez, right, thank you! I think you are correct, i misread it #### BoobyMiles ##### New Member confirmed to all of the above, made some minor edits but the you're both correct on the overarching points. BT > Schweser, but the time required to decipher the notation within questions & answers and time required to find a easily comprehensible answer were two things that if improved upon, however time-consuming, would make a large and immediate impact on the product & its reception in the marketplace, just my two cents. #### David Harper CFA FRM ##### David Harper CFA FRM Staff member Subscriber #### Flashback ##### Active Member Are we supposed to well know the size of each commodity future contract lot on GARP exam (e.g. wheal bushels, ounces of gold, pounds of copper etc) as are required to know in some BT topic questions? #### David Harper CFA FRM ##### David Harper CFA FRM Staff member Subscriber Hi @Flashback I continue to think the guidance in this previous post (see https://www.bionicturtle.com/forum/threads/futures-contract-sizes.4959/#post-13442) applies pretty much. That is: I think you should know the following common contracts; i.e., you probably should memorize them: • Treasury bonds:$100,000 (many questions tend to expect you to know this)
• S&P 500: $250 * index futures price (a popular assumption is questions) • Eurodollar:$1,000,000
• NASDAQ 100: $100 * index futures price • S&P & NASDAQ MINI contracts: one-fifth (1/5th); i.e.,$50 * and \$20 *
The following are likely to be stated in the question; that is, you probably do not need to memorize them. Although each is a popular choice for questions.
• Gold: 100 troy ounces
• Crude oil: 1,000 barrels
• Silver: 5,000 ounces
• Corn (= wheat): 5,000 bushels
• Copper: 25,000 pounds
Please note these can be found at http://www.cmegroup.com/

#### Flashback

##### Active Member
Funny. Thanks. I screwed at least two points because I used incorrect multiplier which wasn't stated in Q in fact I know formulas for hedging pretty well. I will backup this post above.
BTW, I even use metrics system in real life, not this one and have no any experience with trading commodities except commodity ETFs. Lol!