Monday, December 24, 2007

Airasia's crude oil options dealing

In the Star newspaper today, there is a report that Airasia might suffer some setbacks from selling of call options relating to oil (go here). Buried deep in the report entitled "Caucasian crisis deepens" is this item, reproduced in full:

AirAsia Bhd's share price felt a downdraft over the last three weeks. That caused its price to spiral downwards amid heavy selling to a nine-month low of RM1.59 on Friday.

That occurred after two foreign brokers issued reports late last month, warning that the budget airline company was vulnerable to oil options it took on. Counter-parties could exercise their call options to buy oil from AirAsia at US$90 a barrel, which put it at risk if oil rose above that price.

Its CEO Datuk Tony Fernandes said those options “have been taken out with a plain vanilla option at US$79 two weeks ago.” Hence, “there is no exposure anymore” to the early option, he told this column.

It is observed the airline has started to show a trend of high growth as its operating profit rose to RM145.7mil in its first quarter ended Sept 30, 2007 compared with RM52.8mil in the same quarter last year. This could be attributed to economies of scale as Asia's biggest budget airline rapidly expanded under a management astute at managing its fleet operations and finances.

I have highlighted the important part of this report in bold & italic. There are 2 possibilities regarding Airasia's dealing in call options relating to oil.

  • Firstly, Airasia might have sold or written these call options because it felt that oil prices were heading lower & it could do without too much hedging or it might benefit from falling oil prices. Subsequently, the oil prices took a tumble. At that point of time, Airasia could do 2 things: it could choose to do nothing & continue to enjoy the falling oil prices, or it could buy new call options (plain vanilla option, in Tony's word) at lower prices in order to re-establish its hedge against future hike in oil prices.

  • Secondly, Airasia could have sold or written these call options in order to benefit from a correction in oil prices. After oil prices had fallen off, Airasia went into the market to buy new call options (plain vanilla option, in Tony's word again) at lower prices; thus benefiting from the correct prediction of the direction of oil prices.
What is the difference between these 2 scenarios? In the first scenario, Airasia would be viewed as a dynamic airline that watches its most important cost component (oil prices) carefully & actively managing the hedging of this cost component. In the second scenario, Airasia is an overly aggressive company that crossed the line between hedging & speculation in its dealing in call options relating to oil. I do not have the fact to come to a definite conclusion. My feeling is that Airasia is a well-managed company which is not likely to engage in speculative activity as feared by some.

Chart: Crude Oil chart as at December 21 (courtesy of SuperCharts by Omega Research)

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