What Is Future Hedging?
How Can You Profit Using
A Future Hedging Strategy?
The details of hedging can be somewhat complex but the principle is simple. Future hedgers.....
are individuals and firms that make purchases and sales in the futures market solely for the purpose of establishing a known price level--weeks or months in advance--for something they later intend to buy or sell in the cash market (such as at a grain elevator or in the bond market). In this way they attempt to protect themselves against the risk of an unfavorable price change in the interim. Or future hedging may be accomplished by using futures to lock in an acceptable margin between their purchase cost and their selling price.
Consider this example of how a firm can use future hedging:
A jewelry manufacturer will need to buy additional gold from his supplier in six months. Between now and then, however, he fears the price of gold may increase. That could be a problem because he has already published his catalog for a year ahead.
To lock in the price level at which gold is presently being quoted for delivery in six months, he buys a futures contract at a price of, say, $350 an ounce.
If, six months later, the cash market price of gold has risen to $370, he will have to pay his supplier that amount to acquire gold. However, the extra $20 an ounce cost will be offset by a $20 an ounce profit when the futures contract bought at $350 is sold for $370. In effect, the hedge provided insurance against an increase in the price of gold. It locked in a net cost of $350, regardless of what happened to the cash market price of gold. Had the price of gold declined instead of risen, he would have incurred a loss on his futures position but this would have been offset by the lower cost of acquiring gold in the cash market.
Future Hedging Possibilities....
The number and variety of hedging possibilities is practically limitless. A cattle feeder can hedge against a decline in livestock prices and a meat packer or supermarket chain can hedge against an increase in livestock prices.
Banker's and other company's... that loan money can use future hedging to protect themselves. Borrowers can hedge against higher interest rates, and lenders against lower interest rates.
Investors can use the S&P as a future hedging technique by selling S&P futures. Investors can hedge against an overall decline in stock prices, and those who anticipate having money to invest can use future hedging to hedge against an increase in the over-all level of stock prices. And the list goes on.
Whatever the future hedging strategy..... the common denominator is that, most future hedgers, willingly give up the opportunity to benefit from favorable price changes in order to achieve protection against unfavorable price changes.
However, speculators can use commodity options to hedge their positions and still have opportunity for gain.
Individuals can hedge against high gasoline prices... by simply buying a commodity that is rising faster in price. With gas prices rising again it is more important than ever for an individual to protect himself or herself from higher prices. Here is a simple way anyone can hedge againest higher gasoline priceshedge againest higher gasoline prices.
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Home Page Commodity Codes Option Glossary commodity Terms Option Magic QQQ Signals Day Trading Secrets Emini Course Stocks Simulator 30 Year Cycle SP Day Trading Charts Future Hedging Risk Disclosure
There is risk in future hedging. Futures, Options, Stocks and Commodity trading have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in Stocks, Futures, Options and Commodity markets. Don't trade with money that you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell Futures, Options, Stocks or Commodities.risk disclosure