the __earthinc

Analysts expect Malaysian Airlines System to make a loss in the order of RM2 billion for the first quarter of 2009. They attribute the loss to a hedging strategy “gone awry”: in times when jet fuel prices were over USD100 per barrel, MAS made a bet for prices to remain above USD100 per barrel. Now that prices are below USD100, MAS is in trouble.^[1]

It is unclear what kind of hedging strategy MAS used but judging from the article — words like mark-to-market for instance and the fact that MAS is making large loss due to a hedging strategy when prices are below the agreed prices of delivery — I have a feeling that MAS bought future or forward contracts.

Forward and future contracts are commonly defined as a contract between parties to deliver or accept a certain quantity of goods at an agreed future date at agreed prices. Differences exist between the two but I feel they are unimportant in this case. The important characteristic is that at the agreed date, the contract must be fulfilled regardless of gains or loss on any side.

If it is true that MAS bought future or forward contracts, my question would be why?

Would it not be more prudent to purchase options instead of future or forward?

With options, the buyer will have two choices: buy from the spot market or execute the option. When spot prices are below the strike prices, a buyer can simply purchase from the spot market and hence, avoid the kind of loss a buyer would suffer under a future or forward contract.

^[1] — KUALA LUMPUR, June 12 — Malaysia Airlines (MAS) is expected to post a loss, which could exceed RM2 billion, on fuel hedges gone awry for its first quarter to end March.

RHB Research estimated the national carrier’s loss in the region of RM1.7 billion, a projection based on an MAS decision to adopt Financial Reporting Standard 139, requiring the company to recognise mark-to-market losses on its hedges. Industry executives, however, expect the loss to exceed RM2 billion.

When jet fuel was trading at well over US$100 (RM350) per barrel last year, MAS had bet on prices remaining high at around US$100 — but was caught out when the global financial crisis hit last year. The sharp pull-back in business activities quickly dragged down the price of crude oil to less than half at its lowest. [MAS’s Q1 loss expected to top RM2 billion. Business Times Singapore via The Malaysian Insider. June 12 2009]