Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming winter.Customers who took advantage of the offer prepurchased 400,000 gallons of oil at $3.00 per gallon.Swenson hedged its position by contracting to purchase 400,000 gallons of oil for November delivery at a price of $2.50 per gallon.If the November spot price is $2.25 per gallon,the payoff to Swenson is:

Question

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Swenson hedged its position by contracting to purchase 400,000 gallons of oil for November delivery at a price of $2.50 per gallon. If the November spot price is $2.25 per gallon, Swenson will save $0.25 per gallon on each gallon, compared to the contracted price. Therefore, Swenson will save $0.25 x 400,000 = $100,000 in total. As this represents a gain for Swenson, the payoff is negative, or ($100,000).

Swenson Oil & Gas Allows Its Customers to Prepurchase Heating