Hedge physical options with futures on the same physicals

[jessie2016]

Hi all, could you offer me some advice regarding the following question I am now trying to work out? Playing the role of a market maker, I am thinking to make deals on physical commodity options ( options on physicals) with our clients and hedge the option positions with futures that are based on the same physical. As far as I know , we usually hedge the option positions with opposite positions on underlying assets, which should be physicals in this case. However, since it is not possible to long or short physicals in Chinese market( I dont know if it is possible in other markets?) , to hedge with physicals is not applicable. Therefore, I am thinking to use the alternative, futures contracts on the physical, to hedge the physical options. .... Here comes two problems regarding the basis risk: 1) the futures contracts do not necessarily have high positive correlations with physicals, so I have to refer to knowledge in beta hedge 2) to calculate the correlation between physical and its futures is not easy since the same physicals can have different prices in different areas....The correlations are therefore have to be dependent on scenario analysis. ...

With regards to the above two problems in hedging, do you have some advice for me ? or have you ever met any literature that address these problems?

I am looking forward to your answers. Thank you very much. :clap: