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 $2.75 per gallon, the payoff to Swenson is

Question

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Swenson sold 400,000 gallons of oil at $3.50 per gallon for a total of $1,400,000. To hedge their position, Swenson purchased 400,000 gallons of oil for $3.00 per gallon for a total cost of $1,200,000. If the November spot price is $2.75 per gallon, Swenson could have purchased the same amount of oil for $1,100,000. Therefore, Swenson loses $100,000 (($1,200,000 - $1,100,000) * 400,000) from the hedging strategy.

Swenson Oil & Gas Allows Its Customers to Prepurchase Heating