The extraordinary power of options has been demonstrated in recent weeks by three transactions. Sadly, two of these have also shown the lack of understanding and fear that surround derivatives.
In late September and early October, while the price of crude oil was falling from $120 to $90 a barrel, Mexico, the world’s sixth largest oil exporter, bought put options to hedge 100% of its revenues from oil exports next year.
The options were procured privately by Barclays Capital and Goldman Sachs, and news of them did not start filtering into the public domain until November 6.
By locking in a price of $70, Mexico has protected a staggering $37bn of revenue – nearly 40% of public sector income. Without the hedge – or with Mexico’s customary hedge of only 20%-30% of exports – the damage to the country of the recent collapse in the oil price would...