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 $3.50 per gallon. Swenson hedged its position by contracting to purchase 400,000 gallons of oil for November delivery at a price of $3.00 per gallon. If the November spot price is $3.25 per gallon, the payoff to Swenson is

Question

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Swenson Oil & Gas has hedged its position by contracting to purchase 400,000 gallons of oil for November delivery at a price of $3.00 per gallon. As per the question, the November spot price is $3.25 per gallon. So, Swenson would have saved $0.25 per gallon ($3.25 - $3.00) if it had not hedged its position. But since it has hedged its position, it has to pay $3.00 per gallon for the oil, so it saved only $0.25 per gallon. And for 400,000 gallons of oil, this amount saved is $100,000 (i.e. $0.25 x 400,000). Therefore, the payoff to Swenson is $100,000. Thus, the correct answer is A) $100,000.

Swenson Oil & Gas Allows Its Customers to Prepurchase Heating