Commodity, Energy and Climate-Related Hedging

Introduction and context

Commodity markets connect physical production, international trade, finance and public policy. A manufacturer buying copper, an airline buying jet fuel, a utility selling electricity, an agricultural exporter holding wheat, and a bank financing a renewable-energy project all face uncertain prices. Their exposure is not limited to the quoted commodity price. It may also include transport costs, quality differentials, currency movements, location, timing, weather, regulation, carbon prices and changes in technology.

Hedging is the deliberate use of financial or contractual instruments to reduce the variability of an economically relevant exposure. It does not necessarily eliminate risk, and it may introduce liquidity, credit, basis, model and governance risks. The central managerial question is therefore not “Can the price be fixed?” but “Which risks should be retained, transferred or transformed, at what cost, and with what residual exposure?”

Commodity hedging is especially challenging because physical markets are seasonal, geographically fragmented and sometimes capacity-constrained. Energy markets add storage limitations, network congestion and sudden supply disruptions. Climate change increases the frequency and severity of some physical shocks while the transition to a lower-carbon economy creates policy, technology and demand uncertainty.

Learning objectives

By the end of this chapter, the reader should be able to:

1. Explain spot–futures relationships, basis, seasonality and convenience yield.
2. Distinguish price risk from basis, volume, location, quality, currency and climate-related risks.
3. Estimate and interpret minimum-variance hedge ratios.
4. Construct commodity futures, options, swaps and collars for buyers and sellers.
5. Evaluate energy and carbon hedges under transition and physical-climate scenarios.
6. Assess implementation, accounting, collateral, liquidity, model and governance issues.

1. The architecture of commodity exposure

A physical commodity exposure can be represented as a cash-flow profile rather than simply as a price. A firm may be exposed to:

• Price: the commodity’s market value changes before purchase or sale.
• Volume: the quantity actually required or produced is uncertain.
• Basis: the firm’s local price differs from the hedging instrument’s reference price.
• Location: prices vary across ports, hubs, mines, pipelines and delivery points.
• Quality: grade, sulphur content, moisture, calorific value or purity affects value.
• Timing: the physical transaction may occur between futures maturities.
• Currency: the commodity may be quoted in U.S. dollars while operating cash flows are in another currency.
• Operational and regulatory factors: outages, tariffs, sanctions, inventory rules, emissions regulation and margin requirements can affect realized outcomes.

A useful first step is an exposure map identifying the physical quantity, price reference, delivery period, location, currency, volume uncertainty and decision rights. A hedge should be designed around the exposure’s economic driver, not merely around the most liquid contract available.

Long and short exposure

A firm that will buy a commodity later is economically long consumption exposure: an increase in the commodity price raises its future cost. It commonly hedges by taking a long futures position or buying call options. A producer that will sell later is economically exposed to falling prices and commonly hedges with short futures or put options.

The hedge direction must be distinguished from the physical position. A fuel consumer may be physically short fuel until purchase but is financially harmed by rising prices; its derivative position is therefore normally long.

2. Spot, futures and forward prices

The spot price is the price for immediate delivery, subject to the market’s settlement conventions. A forward is an over-the-counter agreement to transact at a specified future date and price. A futures contract is standardized, exchange-traded and marked to market, usually with daily margining.

For a storable commodity under simplified no-arbitrage conditions, the futures price is related to the spot price by a cost-of-carry relationship:

where:

• F_0,T is the futures price for delivery at time T;
• S₀ is the current spot price;
• U is the present value, expressed in currency per physical unit, of storage, insurance and other carrying costs paid before delivery;
• Y is the present value of any non-financial benefit from holding inventory, called convenience yield;
• r is the continuously compounded financing rate; and
• T is time to delivery in years.

This expression assumes a storable, reasonably homogeneous commodity, competitive markets, no material taxes or transaction costs, and the ability to finance, store and deliver the commodity. If carrying costs are quoted as a continuously compounded annual rate, an equivalent representation is:

where u and y are annualized proportional storage-cost and convenience-yield rates. The first formulation is preferable when costs and benefits are measured in currency per unit; the second is useful when they are proportional rates.

Contango and backwardation

When futures prices exceed the spot price, the market is in contango. Contango may arise from financing and storage costs, expectations of future scarcity, or low convenience yield. When futures prices are below spot, the market is in backwardation. Backwardation may reflect high convenience yield, limited inventories or expectations of declining future prices. Neither condition alone proves that prices must rise or fall.

For a commodity that can be stored, arbitrage tends to constrain the futures price. If futures are excessively high, a trader may buy the commodity, store it and sell futures. If futures are excessively low, reverse cash-and-carry arbitrage may be limited because short-selling physical inventory is difficult. This asymmetry is one reason convenience yield matters.

Convenience yield

Convenience yield is the implicit value of physically holding inventory. It can include continuity of production, ability to meet unexpected demand, avoidance of stockouts and compliance with contractual delivery obligations. It is generally unobservable and may rise sharply when inventories are scarce. In electricity, physical storage is limited in many systems, so the traditional storable-commodity formula is only an approximation; prices are shaped by generation availability, transmission constraints, demand peaks and market design.

3. Basis risk and price discovery

The basis is commonly defined as:

where S_t is the relevant spot or cash price at time t, and F_t is the futures price for the selected contract and maturity. Some markets use the opposite convention, F_t - S_t. The convention must be stated because the sign of a change in basis depends on it.

For a short hedge, the hedger sells futures and later buys them back while selling the commodity. With the convention above, the approximate net selling price is:

where F₀ is the initial futures price, S₁ is the final spot selling price and F₁ is the futures price when the hedge is closed. This result assumes one unit of physical exposure and a one-for-one hedge. A stronger basis at exit raises the net selling price for a short hedge; a weaker basis lowers it.

For a long hedge, a buyer purchases futures initially and closes them before purchasing the commodity. The approximate net purchase price is:

under the same basis definition. The expression looks identical, but the interpretation of the futures cash flow differs. A buyer benefits from futures gains when prices rise.

Basis risk arises when the hedging instrument and the physical exposure do not move identically. Sources include:

1. Product basis: the contract grade differs from the physical product.
2. Location basis: the exchange delivery point differs from the firm’s location.
3. Timing basis: the hedge maturity does not match the purchase or sale date.
4. Cross-commodity basis: a related but different commodity is used.
5. Volume basis: the physical quantity is uncertain.
6. Currency basis: the commodity and derivative are denominated in different currencies.

A hedge can therefore reduce outright price risk while leaving economically important residual risks.

4. Hedge ratios and hedge effectiveness

A simple hedge ratio is the fraction of the physical exposure covered by derivatives. If a firm hedges quantity Q with contracts of size q, the contract number is:

where h is the hedge ratio. For a one-for-one hedge, h = 1. The sign is positive for a long derivative hedge and negative for a short derivative hedge if positions are represented algebraically.

Minimum-variance hedge ratio

The minimum-variance hedge ratio is commonly estimated from changes in the spot and futures prices:

where ∆S and ∆F are changes in spot and futures prices over the relevant horizon, Cov is covariance, Var is variance, ρ_SF is correlation, and σ_S and σ_F are standard deviations. The formula minimizes the variance of the hedged price change under a linear hedge and stable, appropriately sampled relationships.

If the exposure is a sale, the firm generally takes a short futures position of approximately N = h^*Q/q. If the exposure is a purchase, it generally takes a long position. The estimated ratio is not a universal constant. It depends on the horizon, contract maturity, market regime, seasonality, location and the measurement frequency used in estimation.

A regression can make the estimation explicit:

The ordinary least-squares slope β is the estimated minimum-variance hedge ratio when an intercept is included and the model is appropriate. The residual ε_t represents unhedged basis and model risk. A high R² is informative but does not guarantee effective future hedging, particularly during structural breaks.

Worked example: minimum-variance hedge

An importer expects to buy 1,000 metric tonnes of a metal. Each futures contract covers 25 tonnes. Historical data indicate ρ_SF=0.80, spot-price standard deviation of 4 currency units per tonne and futures-price standard deviation of 5 currency units per tonne. Therefore:

The estimated number of contracts is:

The importer cannot normally trade 0.6 of a contract, so it must choose 25 or 26 contracts after considering rounding risk, liquidity and the cost of over- or under-hedging. Because it will buy the metal, it would normally take a long futures position. The calculation does not guarantee a fixed purchase price; it targets lower variance based on historical relationships.

5. Seasonality, rolling and maturity selection

Commodity demand, production and inventories often follow seasonal patterns. Natural-gas demand may rise in winter; agricultural harvests alter inventories; electricity demand may peak during heat waves; refinery maintenance can affect petroleum-product spreads. A hedge estimated from annual data can conceal materially different relationships across seasons.

Important design choices include:

• matching contract maturity to the physical transaction;
• using a strip of futures rather than one contract for repeated monthly exposure;
• incorporating seasonal dummy variables or separate seasonal estimates;
• managing roll risk when the exposure extends beyond the nearest contract;
• analysing calendar spreads, such as one delivery month against another;
• considering liquidity, open interest and exchange delivery rules.

A roll yield is the gain or loss associated with replacing an expiring futures contract with a later contract. It is distinct from the change in the underlying spot price. A long investor rolling through contango may incur a negative roll effect, while backwardation may produce a positive one, although the realized result depends on price movements and timing.

6. Futures, options and swaps

Futures and forwards

Futures provide transparent pricing, liquidity and daily settlement, but they require margin and create basis risk. Forwards can be customized by quantity, grade, location, currency and date, but expose the parties to counterparty credit risk and less transparent valuation. A physical forward may also create delivery and operational obligations.

Options

A call gives its holder the right, but not the obligation, to buy at strike price K. A put gives the right to sell at K. The buyer pays a premium and has limited downside beyond that premium.

For a commodity buyer, a call option creates a maximum effective commodity price, ignoring premium and basis:

This compact expression is not generally the cash settlement of the option; it describes the buyer’s commodity cost plus call premium when the option is exercised or expires. C is the premium per physical unit and S_T is the spot price at purchase. If S_T>K, the call payoff offsets the price above K. If S_T≤K, the option expires and the buyer purchases at spot.

For a producer buying a put, the minimum effective selling price is approximately:

where P is the put premium per unit. Options preserve favourable price movements but may be expensive, particularly when volatility, maturity, interest rates or event risk is high.

A collar combines a purchased option with a sold option. For example, a fuel consumer may buy a call at a lower strike and sell a put at a lower price to reduce the net premium. The sold option creates an obligation and limits some benefit from falling prices. A zero-cost collar is not free risk reduction: the firm exchanges premium savings for a bounded price range and contingent obligations.

Commodity swaps

A fixed-for-floating commodity swap exchanges a fixed price for a floating reference price on a notional quantity. A consumer may pay fixed and receive floating, so that increases in the reference price are offset by swap receipts. A producer may receive fixed and pay floating.

If a consumer pays fixed price K and receives floating index I_t on quantity Q_t, its swap settlement is:

Positive settlement is received by the consumer when the index exceeds the fixed price. The formula excludes discounting, fees, collateral and any currency conversion. A swap fixes exposure to the specified index, not necessarily to the firm’s local physical price; therefore basis and volume risk remain.

7. Energy hedging and market structure

Energy risks are shaped by the characteristics of each market.

• Crude oil and refined products: crack spreads link refinery input and product output. A refinery may hedge crude purchases, product sales and the margin between them rather than only an outright oil price.
• Natural gas: regional hubs, pipeline constraints, storage and weather create substantial location and seasonal basis risk.
• Electricity: non-storability, congestion and volatile peak demand make prices highly local and occasionally subject to spikes. Utilities may use forwards, futures, options, swaps and physical contracts.
• Renewable power: output depends on wind, solar irradiance and hydrology. A fixed-price power purchase agreement may leave the buyer exposed to volume and profile risk.
• Carbon: emissions allowances and carbon offsets have regulatory, delivery, permanence and verification risks. Carbon prices may correlate with energy prices but the relationship is unstable.

A producer or consumer should hedge the economically relevant margin. For example, an airline’s exposure is not simply jet-fuel price; it is fuel consumption multiplied by uncertain flight activity, with currency and passenger-revenue interactions. A refinery’s risk may be better represented by a crack-spread hedge than by a crude-only hedge.

8. Climate-related hedging

Climate-related risk has two broad dimensions.

Physical risk

Physical risk includes heat, drought, flood, storm, wildfire, changing precipitation and water scarcity. These can affect commodity supply, transport, demand and asset availability. A weather derivative may pay according to an objective index, such as cumulative degree days or rainfall, but an index payout may not match the firm’s actual loss. This is basis risk in insurance-like form.

Transition risk

Transition risk arises from changes in carbon prices, emissions standards, technology, consumer preferences, subsidies, trade policy and the competitiveness of fossil-fuel assets. A power generator may face a falling utilization rate for a coal plant, while a metals producer may face increased demand for copper or lithium but also higher scrutiny over water, land and community impacts.

Climate hedging should combine market instruments with operational adaptation. Financial derivatives cannot restore a damaged port, replace lost water or solve an inadequate transmission network. Relevant tools include:

• weather and parametric insurance;
• commodity futures, options and swaps;
• carbon allowance futures and options;
• power purchase agreements and contracts for difference;
• diversified sourcing and inventory policies;
• resilient logistics and alternative transport routes;
• energy-efficiency investments and flexible production;
• scenario analysis and stress testing.

Scenario analysis should distinguish probabilities from narratives. A transition scenario may specify carbon prices, demand, technology costs and regulation; a physical scenario may specify temperature, precipitation, yield, transport disruption and recovery time. Correlations can change sharply during climate events, so historical covariance alone is insufficient.

9. Illustrative integrated case: Northstar Foods and climate-sensitive energy exposure

Background

Northstar Foods, a fictional international food processor, expects to consume 12 million litres of fuel over the next six months. Its operating currency is euros, while the relevant fuel benchmark is quoted in U.S. dollars. Production volume is uncertain because drought may reduce agricultural input availability. Management wants protection against a price spike but wishes to retain some benefit if prices fall.

Problem

The company faces fuel-price, volume, currency, basis and climate risks. A simple hedge of 12 million litres could over-hedge if drought reduces production. A benchmark futures contract may not match the company’s delivered fuel grade or location. A fixed-price swap could provide budget certainty but would remove downside benefit and create collateral or counterparty exposure.

Analysis

The treasury team first estimates expected fuel consumption at 12 million litres, with a downside volume scenario of 9 million litres. It compares the local delivered price with the futures benchmark and estimates a historical hedge ratio of 0.78 after accounting for basis behaviour. It also tests relationships separately for normal and disruption periods.

The company chooses a layered program:

1. Hedge 50% of expected volume with long fuel futures, reducing immediate price exposure.
2. Buy call options on a further 25%, limiting the cost of a price spike while preserving downside benefit.
3. Leave the final 25% flexible until production forecasts improve.
4. Use euro–dollar forwards for the dollar value of the projected hedge and physical purchases, with periodic updating as volume changes.
5. Establish a basis-monitoring trigger comparing local delivered prices with the futures benchmark.
6. Stress test a drought, refinery outage, currency depreciation and carbon-price increase occurring together.

For the futures portion, the approximate number of contracts is:

where q is the litres covered by one contract. The options portion is sized using a conservative volume forecast rather than the maximum engineering capacity.

Outcome

In a moderate price increase, futures gains reduce the cost of fuel and call options provide additional protection. If drought reduces production, the unhedged portion prevents the firm from being locked into excessive fuel purchases. If prices fall, the futures hedge loses value, while the call options expire or are exercised only when advantageous. The company still bears local basis, volume and currency risks, but these are monitored rather than ignored.

Learning points

The case illustrates that a good hedge is a portfolio of decisions rather than a single derivative. Layering can reduce timing risk; options can manage volume uncertainty; currency hedging must be coordinated with commodity hedging; and climate scenarios should test joint shocks rather than isolated variables.

10. Governance, accounting and implementation

A professional hedging policy should specify the objective, authorized instruments, benchmark, hedge horizon, hedge ratio range, eligible counterparties, collateral arrangements, valuation methods, escalation limits and reporting frequency.

Collateral and liquidity

Exchange-traded futures generate variation margin as prices change. A hedge can be economically successful but create severe short-term cash needs. Over-the-counter swaps may require initial and variation margin under contractual or regulatory arrangements. Liquidity stress testing should therefore include adverse price moves, volatility spikes, currency changes and reduced access to credit.

Counterparty and legal risk

Over-the-counter contracts require credit assessment, netting documentation, close-out provisions, collateral terms and confirmation controls. Standardized documentation does not eliminate disputes over volume, index publication, disruption events or force majeure. Sanctions, export controls and market-abuse rules may also affect commodity transactions.

Accounting and performance measurement

Economic hedging and hedge accounting are related but not identical. Financial reporting may require formal designation, documentation, effectiveness testing and treatment of excluded components such as time value or forward points, depending on the applicable accounting framework. Treasury should reconcile three measures: economic performance, accounting results and liquidity outcomes.

Model risk and data

Hedge ratios, option valuations and stress tests depend on reliable prices, volumes, correlations, volatility estimates, yield curves and contract specifications. Models should be independently reviewed, back-tested and recalibrated after structural changes. AI and machine-learning tools may improve forecasts of demand, weather or basis, but they do not remove regime shifts, data bias or explainability requirements. Human approval, model inventories, access controls and audit trails remain essential.

11. Limitations and critical evaluation

No hedge is universally optimal. Futures are liquid but may be a poor match for local or irregular exposures. Options protect against adverse tails but require premiums and may be illiquid. Swaps can customize cash flows but add counterparty and documentation risk. Weather derivatives can respond quickly but may pay without actual loss or fail to pay when loss occurs if the index is poorly designed.

The minimum-variance hedge ratio is backward-looking and linear. It can fail when correlations change, price limits bind, markets become discontinuous or the physical exposure is nonlinear. A ratio that minimizes variance may not minimize cash-flow-at-risk, earnings-at-risk or insolvency probability. Managers should compare alternative objectives, including downside protection, liquidity resilience, accounting stability and strategic flexibility.

Climate change adds non-stationarity. Historical data may not represent future weather distributions, infrastructure vulnerability or policy regimes. Climate scenarios should therefore complement, not replace, statistical estimation. The strongest programs combine quantitative analysis with expert judgment, operational adaptation and clear risk appetite.

12. Best-practice framework

A robust commodity and climate-hedging process follows these steps:

1. Define the economic exposure: quantity, timing, location, quality, currency and climate driver.
2. Select the reference index: assess correlation, liquidity, basis and contract terms.
3. Choose the objective: price certainty, variance reduction, tail protection, margin protection or liquidity resilience.
4. Estimate hedge ratios: use relevant data, seasonal segmentation and stress tests.
5. Select instruments: combine futures, forwards, options, swaps, physical contracts and operational measures.
6. Size dynamically: update for volume forecasts, production changes and trigger events.
7. Model collateral and liquidity: include margin calls and counterparty scenarios.
8. Monitor effectiveness: track realized basis, slippage, roll costs, residual exposure and scenario outcomes.
9. Govern decisions: enforce mandates, independent valuation, documentation and escalation.
10. Review the strategy: reassess after market-structure, climate, regulatory or business-model changes.

Chapter Summary

Commodity hedging links physical exposure to financial instruments through spot–futures relationships, basis behaviour and contract design. Cost of carry explains the relationship among spot, financing, storage and convenience yield for storable commodities, while energy markets require additional attention to location, congestion, seasonality, non-storability and operational constraints. Basis risk arises whenever the derivative does not perfectly match the physical exposure.

The minimum-variance hedge ratio, h^* = Cov(∆S,∆F)/Var(∆F), provides a useful statistical starting point, but it is historical and conditional. Futures and swaps can stabilize prices; options and collars manage asymmetric risk; and layered strategies can address uncertain volume and timing. Climate-related hedging must integrate physical hazards, transition risk, carbon exposure, operational resilience and scenario analysis. Effective programs align instruments with economic objectives and govern liquidity, counterparty, model, accounting, legal and ethical risks.

Key Terms

Basis: Difference between the relevant spot price and futures price under a stated convention.

Basis risk: Risk that the hedge instrument and physical exposure do not move together.

Backwardation: A market condition in which the futures price is below the spot price.

Call option: Right, but not obligation, to buy at a specified strike price.

Climate transition risk: Financial risk from policy, technology, market and behavioural shifts toward a lower-carbon economy.

Collateral: Cash or securities posted to secure derivative obligations.

Convenience yield: Non-cash benefit obtained by holding physical inventory.

Contango: A market condition in which the futures price exceeds the spot price.

Cost of carry: Financing, storage, insurance and related costs of holding a commodity.

Futures contract: Standardized exchange-traded agreement for future delivery or cash settlement.

Hedge ratio: Proportion of physical exposure hedged with a derivative.

Long hedge: Purchase of derivatives to protect against rising prices for a future purchase.

Minimum-variance hedge ratio: Ratio that minimizes variance of a hedged price change under stated assumptions.

Physical risk: Risk from climate hazards such as drought, flood, heat and storms.

Put option: Right, but not obligation, to sell at a specified strike price.

Roll yield: Gain or loss associated with replacing one futures maturity with another.

Spot price: Price for immediate delivery under market conventions.

Swap: Contract exchanging a fixed commodity price for a floating reference price.

Volume risk: Risk that the quantity produced, consumed or delivered differs from the hedged quantity.

Review Questions

Short Answer Questions

1. What is convenience yield, and why can it increase when inventories are scarce?
2. Define basis using the convention b_t = S_t - F_t.
3. Why does a fuel consumer generally take a long futures position?
4. State two sources of basis risk.
5. What is the principal advantage of buying a commodity call option?

Long Answer Questions

1. Explain the cost-of-carry relationship and discuss its assumptions and limitations.
2. Derive and interpret the minimum-variance hedge ratio using covariance and variance.
3. Compare futures, options, forwards and swaps for an industrial commodity buyer.
4. Explain how seasonality, rolling and maturity selection affect hedge effectiveness.
5. Discuss how physical and transition climate risks should be incorporated into a corporate hedging policy.

Analytical / Application Questions

1. A producer expects to sell 5,000 tonnes of a commodity. Each futures contract covers 50 tonnes, and the estimated hedge ratio is 0.72. Determine the approximate number and direction of futures contracts, and identify two residual risks.
2. An importer’s spot and futures price changes have correlation 0.75, spot standard deviation 6 and futures standard deviation 8 currency units per tonne. Calculate the minimum-variance hedge ratio and explain whether the importer should buy or sell futures.
3. Design a layered hedge for a power-intensive manufacturer whose electricity volume is uncertain, prices are location-dependent, and carbon regulation may tighten. Justify the instruments and identify liquidity, basis and governance risks.

Multiple Choice Questions with Answers

Question 1

Under the stated basis convention, which expression defines basis?

A. b_t = S_t − F_t

B. b_t = S_t + F_t

C. b_t = F_t ÷ S_t

D. b_t = S_t × F_t

Correct Answer: A. b_t = S_t − F_t

Question 2

A firm that expects to purchase a commodity later and wants protection against rising prices will normally use which position?

A. Short futures

B. Long futures

C. Short call only

D. Long put only

Correct Answer: B. Long futures

Question 3

If correlation is 0.80, spot standard deviation is 4, and futures standard deviation is 5, the minimum-variance hedge ratio is:

A. 0.16

B. 0.64

C. 1.25

D. 4.80

Correct Answer: B. 0.64

Question 4

Which factor is represented by convenience yield?

A. The exchange’s contract fee

B. The benefit of physically holding inventory

C. The futures margin deposit

D. The currency conversion spread

Correct Answer: B. The benefit of physically holding inventory

Question 5

A call option gives its holder the right to:

A. Sell the commodity at the strike price

B. Buy the commodity at the strike price

C. Receive a fixed interest rate

D. Avoid all basis risk

Correct Answer: B. Buy the commodity at the strike price

Question 6

If a futures contract covers 25 tonnes, a 1,000-tonne exposure with hedge ratio 0.64 requires approximately:

A. 16 contracts

B. 25.6 contracts

C. 40 contracts

D. 64 contracts

Correct Answer: B. 25.6 contracts

Question 7

Which risk is particularly important when a local physical price is hedged with a different regional futures benchmark?

A. Basis risk

B. Patent risk

C. Depreciation risk

D. Inventory counting risk

Correct Answer: A. Basis risk

Question 8

In a fixed-for-floating swap, a commodity consumer paying fixed and receiving floating generally benefits when:

A. The floating index rises above the fixed price

B. The floating index falls below zero only

C. The physical volume becomes certain

D. The futures exchange closes

Correct Answer: A. The floating index rises above the fixed price

Question 9

Which is an example of physical climate risk?

A. A new emissions-trading rule

B. A change in consumer preference for electric vehicles

C. A drought disrupting agricultural supply

D. A change in accounting policy

Correct Answer: C. A drought disrupting agricultural supply

Question 10

Why may a minimum-variance hedge ratio fail during a major market regime change?

A. It is based on relationships that may no longer be stable

B. It always assumes options are used

C. It eliminates all volume risk

D. It does not require price data

Correct Answer: A. It is based on relationships that may no longer be stable