A US-based airline expects to purchase 1 million gallons of jet fuel in 3 months. The company is concerned that fuel prices will rise. To hedge this risk, the company should:

Answer options:

Sell jet fuel futures contracts.

Buy jet fuel futures contracts.

Buy put options on jet fuel.

Do nothing, as fuel prices are cyclical.

How to approach this question

Identify the risk exposure: Risk is price rising. Identify the position: Need to buy asset. Hedge: Take a Long position (Buy futures or Call options).

Full Answer

B.Buy jet fuel futures contracts.✓ Correct

The airline is exposed to the risk of rising prices (input cost). To hedge this, it should take a 'long' position in futures. If prices rise, the profit on the futures contract will offset the increased cash cost of purchasing the fuel.

Common mistakes

Confusing buy/sell positions; confusing call/put options.

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