How does hedging using futures work?

Global Markets
1

I can’t understand how it makes sense. From what I’ve read, corn producers (for example) sell their corn at current price but deliver the corn later, in order to protect themselves from decline in corn prices. On the other hand, those who buy corn agree to current price in order to protect themselves from potential increase of corn prices. But in the end, one of them is going for profit from this (corn producer if prices fall, buyer if prices raise). Let’s say price of corn rose. Essentially, the producer of corn didn’t protect himself - he just lost money on that trade.

The only way I see this work for the producer is if there is >50% chance that price of corn will decline, but if that’s the case then buyers of corn wouldn’t agree to that trade.

So in the end, doesn’t it all even out? Sometimes the producer will make money sometimes he will ‘lose’.

2

If it costs the producer $10 to produce a ton of corn, any sale at above $10 is a profit, no matter where price goes after the agreement is reached.

If he doesn’t sell the corn, its going to cost him additional money to the $10 production cost to deal with it…

So if he sells at £12, he always makes a gross $2 a ton / 20% profit. Even if corn goes to $100 a ton, he’s still in the money.

The buyer is down $12 but has the corn. If corn goes up to $14, he’s saved $2 a ton. If corn goes down he’s paid more but he still has the corn. There is always the possibility that if corn prices fall, it gets bought up by bigger players or shipped out to other markets and our guy ends up with less corn than he wanted, so he has to use an alternative feed or source corn from another market, both adding to his costs.

3

Quite so @tommor, just what a lad needs - 8 am Sunday morning - 3.000 tons of corn arriving at the door to your apartment :slight_smile:

1 Like
4

you are applicting wrong assumtions in your thoughts.

the idea is to have price stability for production. not to speculate on gain or loss.

before i write a wall of text, does this answer your question?

5

Most of the traders use hedge to nullify the wrong move on an existing trade. It is a good technique to save a lot of money. Sometimes you have to stay safe from certain losses by gaining same profit in order to make them equal with no profit-no loss.

6

“There’s always one” :grimacing:

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7

It really demeans and devalues the forum, to have nonsense like this posted all over the place.

The problem is that if it isn’t firmly corrected, some totally inexperienced new members might imagine that it’s actually true. :scream:

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8

You’re exactly right.

It’s the “Babypips problem” I was just discussing with Peterma here: Any Demo Trading platform with “stop-limit” feature

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9

Long hedging

End-users take a long position when they are hedging their price risks. By buying a futures contract, they agree to buy a commodity at some point in the future. … Offsetting a position is done by obtaining an equal opposite on the futures market on your current futures position.

10

Exactly how UnaAllan explained. There are commodity traders on the market who never actually see goods. They are trading on price differentials between long and short futures.