Backtesting Delta Hedges for Options on Oil Futures
Summary
The document considers how to compare hedging strategies for two models that price options on WTI crude oil futures. It questions whether a traditional delta hedge is meaningful when the underlying is a futures contract, since buying or selling futures does not require paying the full underlying value upfront, apart from transaction costs. A response suggests comparing hedged return and risk distributions using deltas calculated from different implied volatilities, with a simulated or historical evaluation tailored to where the models differ most. A delta-hedged options position designed to expose skew differences is offered as an example.
The replies caution that historical backtests show only one realized price path, which cannot establish the true underlying dynamics. Simulation can help isolate model assumptions, but depends on the chosen data-generating process. Another response notes that oil futures hedging should account for margin calls and changing liquidity requirements. The document offers design considerations rather than a complete implementation, dataset, or empirical comparison, and it does not specify transaction-cost, margin, or liquidity models.
Key ideas
- A comparison can evaluate the risk and return of hedges using deltas from competing implied-volatility models.
- The test should focus on market features where the models make meaningfully different assumptions.
- Simulation can compare model behavior, while historical backtests represent only one realized price path.
- Oil futures hedging analysis should account for margin calls and changing liquidity requirements.
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Full text
# Implementing a hedging strategy for oil future options # Implementing a hedging strategy for oil future options I am currently writing a paper examining two models for pricing options on WTI Crude oil futures, and I want to backtest hedging strategies from both model and compare them against each other. However, I am having some trouble visualizing how the backtest should look like. My initial thought was to implement a traditional delta hedge but as the underlying is a futures there is no cost of buying/selling the underlying (if we disregard transaction costs etc). How can I implement a meaningful hedging strategy using futures and options on futures? EDIT: Any links to papers on this topic is also greatly appreciated! Thanks and apologies if the question is unclear. ## Answer by klib (score 1) https://quant.stackexchange.com/a/65401 Most of the academic papers I have seen use simulated data rather than backtesting on historical data because historical data only gives you one price path and the true underlying dynamics can not be known for certain. I think you are looking for a paper like: Which Free Lunch Would You Like Today, Sir? Delta Hedging, Volatility Arbitrage and Optimal Portfolios. In this paper the authors examine the differences in return/risk profiles when hedging with a delta calculated from different implied vols. For your paper I would recommend thinking about what the two models assume about the underlying and where that difference would be most extreme. For example, if the main difference in the model is related to skew then run a simulation or backtest comparing the return distribution of a delta hedged fence (long otm call and short an otm put hedged with the delta). ## Answer by Kareem Sayed (score 0) https://quant.stackexchange.com/a/64156 Adding on to @noob2's answer, there is both a implied probability of a margin call and changing liquidity requirements when trading oil futures. Backtesting a strategy that involves hedging using futures should take these into account
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