Best Number of Futures Contract in a Hedge

This video provides an explanation of how to calculate the appropriate number of futures contracts to use in a cross hedge.  He provides an example using the airline industry whose success is very dependent on hedging the costs of fuel.  There is no futures contract which can perfectly hedge the costs of jet fuel; therefore, a cross hedge will have to be created to mitigate risk as much as possible.  A cross hedge is an imperfect hedge which attempts to offset the cost of one commodity by hedging it with a similar commodity. 

In this example, jet fuel will be cross hedged with heating oil futures, which readily trade on the NYMEX.  The example walks through the calculations required to create an optimal hedge to minimize the variance in the hedge.  The key to the calculation is determining the hedge ratio which is calculated using the correlation factor between prices of both commodities and the standard deviation in prices of both.