6 ms·

Interestingly airlines are divided on hedging and not all participate in it https://www.eurofinance.com/news/airlines-divided-on-hedge-benefits-as-oil-volatilit

Interestingly airlines are divided on hedging and not all participate in it https://www.eurofinance.com/news/airlines-divided-on-hedge-benefits-as-oil-volatility-surges/ https://www.eurofinance.com/news/airlines-divided-on-hedge-b...

selectodude 7y ago
You can make an indirect bet on oil futures by trading airline stocks. Southwest Airlines (LUV) if it's going up, American Airlines (AAL) if it's going down.
refurb 7y ago
Fascinating article! To hedge or not to hedge basically comes down to US versus EU accounting rules.
joosters 7y ago
Hedging is extremely odd in that while it is thought of as a way to lock in 'certainty' on the price of something, it really is just another way of gambling on a price. In the case of airlines, they are effectively 'short' oil, in that they profit if the price of oil falls, and lose if the price rises. So the usual story is that it makes sense to hedge their oil costs. They can do this in three main ways: 1) Buy oil forward. They get to lock in the price of oil at a future time. If oil prices rise, they win. But if oil prices fall, they lose out, since competitors can now buy oil more cheaply. 2) Buy a call option on oil. They get the right to buy oil at a fixed price at a future time. If oil prices rise, they can exercise the option, and win. If oil prices fall, they can just take the cheaper price => another win. But the option itself has a cost, so if oil prices don't change much, they lose out since they had to eat the cost of buying the option. 3) Sell a put option on oil. This is the airline being paid by someone for the option to sell them oil at a fixed price at a future time. In this case, the airline wins if oil prices don't move too much in any direction (since they get paid for the put option). If oil falls in price, they will have to buy it at the higher price => they lose. If the oil price rises, they also lose since the costs have risen. Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. The choice whether to hedge or not is really down to game theory. What matters is not just whether/how your airline hedges, but what your competitors do.
- elemeno 7y ago
  > Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. That’s not really true. You’re locking in the price that you’re going to pay - that’s the certainty. You might however not be getting the best price at that point in time. From a financial forecasting perspective it probably worthwhile trade off though as you’re fixing one of your costs for that time period and that’s useful even when sub optimal.
  - joosters 7y ago
    There's still no certainty. For an airline, your prices have to be competitive. If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors (assuming that they didn't hedge in the same way). So the only certainty there is failure. In all situations, hedging and non hedging, the oil price will determine whether you win or lose. There is no magical combination of derivatives that will ensure success. In fact, for every financial product you buy, you're paying a cost due to the margin that the bank/market charged you. Hedging might make sense for some accounting/tax situations, but that's another issue entirely.
    - fennecfoxen 7y ago
      "If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors." No. Your fares will remain competitive. It's just a hit to your profits.
      - joosters 7y ago
        You are free to lose money by keeping the prices competitive, or lose money by raising your prices and losing business. Either way, it's the same result.
    - 1998v2 7y ago
      Airlines sell tickets in advance, so hedging will allow them to match their near-future fuel prices to the ticket prices they're selling now. They consume fuel but don't produce it, so I don't think they can fully balance things out over time internally. edit: I see this was mentioned already in the thread.

selectodude 7y ago

You can make an indirect bet on oil futures by trading airline stocks. Southwest Airlines (LUV) if it's going up, American Airlines (AAL) if it's going down.

refurb 7y ago

Fascinating article! To hedge or not to hedge basically comes down to US versus EU accounting rules.

joosters 7y ago

Hedging is extremely odd in that while it is thought of as a way to lock in 'certainty' on the price of something, it really is just another way of gambling on a price. In the case of airlines, they are effectively 'short' oil, in that they profit if the price of oil falls, and lose if the price rises. So the usual story is that it makes sense to hedge their oil costs. They can do this in three main ways: 1) Buy oil forward. They get to lock in the price of oil at a future time. If oil prices rise, they win. But if oil prices fall, they lose out, since competitors can now buy oil more cheaply. 2) Buy a call option on oil. They get the right to buy oil at a fixed price at a future time. If oil prices rise, they can exercise the option, and win. If oil prices fall, they can just take the cheaper price => another win. But the option itself has a cost, so if oil prices don't change much, they lose out since they had to eat the cost of buying the option. 3) Sell a put option on oil. This is the airline being paid by someone for the option to sell them oil at a fixed price at a future time. In this case, the airline wins if oil prices don't move too much in any direction (since they get paid for the put option). If oil falls in price, they will have to buy it at the higher price => they lose. If the oil price rises, they also lose since the costs have risen. Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. The choice whether to hedge or not is really down to game theory. What matters is not just whether/how your airline hedges, but what your competitors do.

elemeno 7y ago
> Yet, in all cases, after hedging, the airline will still either win or lose depending upon the change in oil price. No certainty has been gained. That’s not really true. You’re locking in the price that you’re going to pay - that’s the certainty. You might however not be getting the best price at that point in time. From a financial forecasting perspective it probably worthwhile trade off though as you’re fixing one of your costs for that time period and that’s useful even when sub optimal.
- joosters 7y ago
  There's still no certainty. For an airline, your prices have to be competitive. If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors (assuming that they didn't hedge in the same way). So the only certainty there is failure. In all situations, hedging and non hedging, the oil price will determine whether you win or lose. There is no magical combination of derivatives that will ensure success. In fact, for every financial product you buy, you're paying a cost due to the margin that the bank/market charged you. Hedging might make sense for some accounting/tax situations, but that's another issue entirely.
  - fennecfoxen 7y ago
    "If you've locked in an oil price, and it turns out to be a high one, then your fares will be more expensive than your competitors." No. Your fares will remain competitive. It's just a hit to your profits.
    - joosters 7y ago
      You are free to lose money by keeping the prices competitive, or lose money by raising your prices and losing business. Either way, it's the same result.
  - 1998v2 7y ago
    Airlines sell tickets in advance, so hedging will allow them to match their near-future fuel prices to the ticket prices they're selling now. They consume fuel but don't produce it, so I don't think they can fully balance things out over time internally. edit: I see this was mentioned already in the thread.