Hedging For Dummies

In this Forbes article (reg required) HedgeStreet is taken to task for its wide spreads and poor volumes. Some of the more wince-inducing quotes:

"Indeed, the pathetic trading volume, gaping bid/ask spreads and ridiculously short contract maturities (rarely stretching beyond 7 days) are enough to make any intelligent investor's hair curl."

"Trading volume last year was all of 1 million contracts, worth $5 million. By way of contrast, the Chicago Merc does $3 trillion in one day of trading."

As more relavent issues to Risk Market followers are costs, "Take a $59 oil Hedgelet maturing Feb. 15 (the latest available on Feb. 14). Buy it and you collect $10 if oil's ending price is above $59 but nothing if the price ends at or below $59. Take the other side of the bet and you collect $10 if the price ends below $59.

Say it will cost you $8 to buy the bullish bet. A seller puts down $2 for the bearish bet. Now, making a comparison to a mainstream commodity option requires a little work on the back of an envelope. Roughly speaking, the simultaneous purchase of 50 bullish $59 Hedgelets and 50 bullish $60 Hedgelets would have the same payoff as buying one $59 Nymex call and selling one $60 Nymex call. (With either pair of trades you get no payout if oil ends below $59, $1,000 if oil ends above $60 and something between $0 and $1,000 if oil ends in between.) As of Feb. 14 the two Hedgelet trades would have cost you $600 at asked prices. The Nymex strategy would have cost you $510."