The long hedge
Buyers of agricultural products by definition need protection against rising prices.For
example, suppose a feed producer plans to buy feed wheat in December. The cash
market price now for feed wheat delivered in December is 187 euros per ton.
However,
the producer is afraid that the price will rise and wants to hedge (hedge) this
risk. He does this by buying futures at a rate of 187 euros per tonne in
December.
If the
price does indeed rise to 195 euros per ton, the feed producer will be
compensated by the result on the futures market:
In this
example, the higher cost of wheat was offset by a profit on the futures market.
|
Cash Market |
Futures Market |
May |
Feed Wheat is 187€/t |
Buy Dec Futures at
187€/t |
December |
Buy Feed wheat at 195€/t |
Sell Dec Futures at
195€/t |
Change |
8 €/t loss |
8€/t gain |
|
Buy cash wheat at |
195€/t |
|
Gain
on Future position - |
8€/t |
|
Net
Purchase price |
187€/t |
Conversely,
if wheat prices were to fall by EUR 7 per ton, the lower cost of wheat on the
spot market would have been offset by a loss on the futures market. The net
purchase price would still be 187 euros per ton:
|
Cash Market |
Futures Market |
May |
Feed Wheat is 187€/t |
Buy Dec Futures at
187€/t |
December |
Buy Feed wheat at 180€/t |
Sell Dec Futures at
180€/t |
Change |
7 €/t gain |
7€/t loss |
|
Buy cash wheat at |
180€/t |
|
Loss
on Future position + |
7€/t |
|
Net
purchase price |
187€/t |
The
producer could also have chosen to actually buy the raw material in advance
from his suppliers. This is called an (OTC) Forward contract. The effect of
this is approximately the same as a Future contract, namely that you have set
prices in advance. The difference is that you can make all kinds of different
agreements in an OTC forward contract regarding delivery, quality, etc. On the
other hand, you always have to find a counterparty for those types of
contracts. Something that costs little effort in standard markets due to
standardization.
Covering
price risk on the purchasing side enables the feed producer to make price
agreements for the longer term without running the risk of the market turning
against him and losing money on it. That makes long-term pricing in the chain
less risky.
Want to know more about risk management? Or the use of forward contracts and forward contracts, perhaps to make chain agreements? Then call 0320 269 523 or mail to contact@dca-markets.com.