Hedgers: Minimizing Risk - FuturesHound.com the Futures Portal

Brokers

HOME / Fundamentals of Futures / MARKET DYNAMICS

Email this to a friend

Print HTML

Hedgers: Minimizing Risk

CME Group, CME Group

Published 09/23/2008 - 1:24 a.m. EST

Rate This Article:

ABOUT THE AUTHOR

CME Group

Website:
http://www.cmegroup.com

Hedging is a primary function of the futures market. Hedging is the buying and selling of futures contracts to offset a particular risk.

1. Hedgers typically own a cash commodity (known as having a long position)
2. A perfect hedge eliminates all risk; perfect hedges are very rare
3. Hedgers can be anyone: farmers, pension fund managers, global companies, manufacturers

Hedging is a primary function of the futures markets. Hedging is the buying and selling of futures contracts to offset a particular risk a company may face. This risk may relate to the price raw materials, such as oil or corn, or to financial risk, such as foreign exchange rates, interest rates or the level of the stock market. Since a firm is only profitable as long as what it produces exceeds the cost of the inputs, if costs change too dramatically a firm may quickly become unprofitable. This risktransfer
mechanism has made futures contracts virtually indispensable to companies, farmers and financial institutions around the world for over a century.

Hedgers are individuals or companies that own a cash commodity, or are planning to own a cash commodity (corn, soybeans, wheat, U.S. Treasury bonds, notes, bills, etc.). This is known as having a long position. Therefore, these companies are concerned that the cost of the commodity may change before they either buy it or sell it.

To alleviate some of that concern, they seek price protection by hedging the commodity. Almost anyone who seeks protection against unwanted price changes in the cash market can use the futures markets for hedging, including farmers, merchandisers, producers, exporters, bankers, bond dealers, insurance companies, money managers, pension fund managers, portfolio managers, thrifts,
manufacturers, and others. Farmers hedge the price of their crops against the price going down.Heating oil distributors hedge the value of their heating oil inventory.

A perfect hedge is one that completely eliminates risk; perfect hedges are rare. Therefore most hedging activities do not eliminate risk; rather, they minimize the exposure to risk…which means a hedge can sometimes fail. This is the realm of risk management.

Video: Role of Hedgers in Currency Markets file

Video: Role of Hedgers in Agricultural Commodities file

Legal Disclaimer and Risk Disclosure: Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leverages investment, and because only a percentage of a contractâ€™s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All orders are entirely at your risk, and it will be your responsibility to monitor these orders. There are limitations to the protection given by stop loss orders therefore we give no assurance that limit or stop loss orders will be executed, even if the limit price is met, in full or at all.