SearchLacima has recently enhanced its LNG offering by incorporating ‘rolling intrinsic hedging’ functionality
Rolling intrinsic is an advanced strategy which involves regular hedging of an LNG deal intrinsic value, typically on a daily or monthly basis. This approach captures the extrinsic value during shifts in an option’s status within the LNG contract—from being ‘out of the money’ to ‘in the money’ (or the other way around). During these transitions there can be substantial adjustments in the expected nomination decisions of the contract. For example, a cargo delivery might be more profitable to send to Asia, rather than Europe, and the hedging adjustments capture this shift in the contract’s worth.
One of the key advantages of the rolling intrinsic strategy is the ability to limit downside risks through hedging.
This approach stabilises profit range and limits downside risk, however, this safety net comes at the cost of losing some potential high gains and a slightly reduced expected value, mainly due to the associated trading costs.
To demonstrate, the chart below shows an unhedged LNG contract whose initial intrinsic value ranges from a loss of $600 million to profit of $1.1 billion. However, under a rolling intrinsic strategy, this variation in value is significantly reduced, ranging from a nil gain to a profit of $300 million. This strategy effectively eliminates potential losses from the initial intrinsic value. While it retains some upside, it also caps larger gains.
Rolling intrinsic hedging is particularly effective for contracts with a large number of options. It effectively manages downside risk while maintaining a portion of the upside potential. As options move between being in and out of the money, rolling intrinsic captures value from each of these events.
Lacima Analytics>LNG offers enhanced functionality for users to calculate total, intrinsic, and extrinsic value, along with the distribution of these values. It enables a detailed comparison of the risk-reward profile under both unhedged and rolling intrinsic strategies. Additionally, it provides in-depth access to individual simulations, allowing users to effectively assess and compare strategies against the specific objectives and risk-reward profiles of an LNG business.
For more information or for a demonstration, please contact us.
