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Hedging a European ETF Tracking a US Oil Company

Article Quant Q&A · Author: uzumaki
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Summary

The document distinguishes between an ETF’s actual exposure and a proposed hedge based on oil prices. If an ETF tracks shares of a US oil company, its direct exposure is to those shares; an issuer would generally hold the underlying stock, with a possible currency hedge if the product has quanto features. A rise in Middle Eastern oil prices does not create a direct oil-price exposure in the ETF by itself.

If direct access to the US shares is unavailable, crude futures might be considered as an imperfect proxy, but the answer stresses several sources of basis risk: crude benchmarks may diverge, oil prices and company shares do not move in perfect correlation, and futures rolls have costs. It argues that crude futures are a poor substitute for the stock exposure. The response is a conceptual interview-style discussion and does not provide a hedge ratio or quantitative analysis.

Key ideas

  • An ETF tracking a US oil company is primarily exposed to the company’s shares, not directly to Middle Eastern crude prices.
  • An ETF issuer would normally hold the underlying shares and may hedge currency exposure for a quanto product.
  • Crude futures can be an imperfect proxy when the stock is inaccessible.
  • Benchmark spreads, imperfect stock-oil correlation, and futures roll costs create hedge risk.
  • The document gives no quantitative hedge ratio or evidence from a tested strategy.

Tags

EquitiesCommoditiesFuturesForexRisk management
Full text
# Interview question on etf


# Interview question on etf












If the ETF in the European market is tracking an oil company in the US, and now the oil price in the Middle East is likely to rise, how should I hedge this position?

P.S- I am preparing for Flow Traders interview. Does anyone have an idea about what they ask and what is their case study is about? Any help is appreciated. Thanks

## Answer by Lliane (score 2)

https://quant.stackexchange.com/a/31252

Your question is not very clear, hedge which position ?

If you are the ETF issuer then you shall hold the US oil companies shares, period (eventually a fx hedge if your ETF is quanto), you have no direct exposure to Middle East oil prices.

If the question is how to replicate a long exposure to a US stock when you are in Europe, with no access to the US underlying. There is no definitive answer to that, use your imagination, mention the spread between Middle East crude and US or EU crude, the non-perfect correlation between crude prices and share prices that might impede the hedge, the cost of rolling the futures, etc. But it doesn't make sense, it would be suicidal to build an ETF on US oil shares by hedging with crude oil futures.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.