Rollover basis risk

[[email protected]]

Hi David,
I have a question about rollover basis risk.

"Rolling the hedge is exposed to: basis risk from the original hedge and basis risk from each new hedge". The original hedge is closed out when we roll into a new one. Why do we still have the basis risk from the original hedge?

Thanks.

 

[David Harper CFA FRM]

Hi ldcn,

What is the source for "rollover basis"? ... Is that a T9. current reading, I can't recall?

I agree with you, but i don't read your implication into the quote. I think:

• The basis risk is persistent to the hedge and pretty much always exists as long as the hedge is on; it is generally an unavoidable risk that the hedge cannot perform perfectly as it is not a perfect identity to the underlying
• The rollover risk (that's why i am asking for the source) i think just refers to the risk in the roll return (e.g., a loss in roll return is implied by contango)
• So "rollover basis" is either, to my thinking (i) an awkward pairing of two different risks or (ii) something more exotic w.r.t. to the roll return
• But, yes, i do agree with you: while the basis risk persist, for example in the stack and roll, as one forward is closed and another one entered, it doesn't belong to the closed contract. But i will take a closer look if you cite the source, i know i've seen "rollover basis" but i can't recall where

thanks, David

 

[[email protected]]

Thanks for detailed answer. The quote is from your FRM notes of financial markets and products, under the AIM of describe what is meant by “rolling the hedge forward” and discuss some of the risks that arise from such a strategy.

 

[David Harper CFA FRM]

Hi ldcn, thanks, I see it! ... I think it's poorly written (sorry) and not sure where I picked up the "rollover basis risk." I agree with you original point, and i don't like "rollover basis" because it blends two risks. I would prefer:

• Rolling the hedge closes out one future contract (basis risk belonged to that hedge, but with the gain/loss is realized)
• Rollover risk (i.e., roll return negative in contango)
• Take same position in NEW futures contract (basis risk created, or "re-newed" so to speak, but only one basis risk as basis risk is a function f[S-F]).

Thanks for pointing that imprecision out, David

 

[afterworkguinness]

Hi ldcn, thanks, I see it! ... I think it's poorly written (sorry) and not sure where I picked up the "rollover basis risk." I agree with you original point, and i don't like "rollover basis" because it blends two risks. I would prefer:

• Rolling the hedge closes out one future contract (basis risk belonged to that hedge, but with the gain/loss is realized)
• Rollover risk (i.e., roll return negative in contango)
• Take same position in NEW futures contract (basis risk created, or "re-newed" so to speak, but only one basis risk as basis risk is a function f[S-F]).

Thanks for pointing that imprecision out, David

Hi David,
Am I correct in my understanding that there is no additional basis risk in a stack and roll hedge vs a longer term hedge where you are not rolling over the hedge ?