So my background is primarily in natural gas derivatives across the forward curve. Not much exposure in inter-commodity. If I’m trying to trade CL and NG, what would be spreading syntax? Is it CL-NG or CL/NG or CL(10NG)? Pretty much I’m trying to find to make it BPV weighted hedge to be exposed specifically to the spread. CL-NG wouldn’t make any sense because that’s essentially trading the front leg because of the beta component.
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Even though these both have a tick value of ten... CL-NG will pretty much look like the CL chart. It's practically trading CL flat price... this can't be right, right?
And CL/NG will have a ratio mismatch and BPV won’t be the same and will have a higher delta risk in the second leg
So you're essentially looking for a hedge ratio? The usual way to do this would be to use beta on returns - so the number of CL contracts to hedge 1 NG would be Covar(NG, CL) / std(NG).
Obviously this won't be a perfect model though - given the difference in volatility the spread is unlikely to be stable.
Depending on how quantitative you want to get, there are a lots of statistical tools you could use to solve this problem.
I'd be keen to learn more about NatGas derivs so if you want to trade knowledge PM me.
Sounds like this is useful when you're out the curve and you need to hedge with a front and because longer tenors are less liquid and less volatile. Even the notion differs, essentially they should move close, not perfect, in linear? I think this is what it's measuring, right? I think you may be right... This is something similar to a stack and roll.
Pretty much ratio hedge based on the realised volatility
The obvious answer is to weight it by notional value. So 100 contracts of crude is like aprox 5.8mm usd, so would sell the equivalent Amount of natty contracts. This is how commodity index funds over/underweight products.
You could also just calc the standard deviation of crude, and standard deviation of natty. Once you have the size of 1sd move, you figure out how many contracts for a fixed amount of risk, say 100k. Then you do the same for natty
Answer above is wrong, hedge ratio is useless since you want to take a view on the spread, not some kind of simple statarb trade.
This makes sense because just to give an example... The SOFR 1mo futures is like 4.167mm and the fed funds is 5mm... essentially their risk are the same and the CME completely fucked up the contract specs when SOFR was released.. so I actually asked my static data team to change it andkeep the SOFR 1mo notional 5mm even though it doesn't follow the street via FRTB... Butwhich will pretty much keep the PV01 equivalent. I assume this is kind of like what you're referring to
notional value weights only works when the prices move in tandem. this doesn't work for example with interest rates...100 2yr notes has very different interest rate risk from 100 30yr bonds...something around the order of 10x differential.
I agree with you but we’re not talking about cash
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