Hedging with Futures and Options
Learn the most effective strategies for buying and selling options
on futures contracts. Also learn producer and consumer hedging
strategies.
Formula for setting a
price floor with
options = strike price + basis - total cost of the put option.
Formula for setting a
price ceiling
with options = strike price + basis - total cost of the call option.
Hedging:
Method of reducing risk of loss caused by fluctuations in the
underlying cash commodity markets. A 100% hedge consists of the
purchase or sale of equal quantities of the same or similar
commodities in two different markets at approximately the same time
with the expectation that a future change in one market will be
offset by an opposite change in the other market. Read
The No Nonsense Guide to Buying and Selling Options to learn
more about hedging with options on futures contracts.
A basic assumption is that the futures markets will move in a
similar fashion to the cash markets. So a farmer with 5,000 bushels
of corn wants to hedge his corn because he likes the idea of locking
in at $4.50 per bushel. He can sell one futures contract at $4.50 to
give himself a 100% hedge for his corn. If corn goes higher, he will
make more money on his physical corn but this profit will be offset
by the equal losses incurred by his short futures position.
*Here are a couple of hedging brochures courtesy of the CME Group.
Livestock
Hedging Brochure
Grains and Oilseeds Hedging Brochure
Broker Assisted Hedging
If you are a producer or end user of a commodity and would like help
to hedge your price exposure to fluctuating markets, you can work one
on one with our company president,
Michael K. Smith. He
will work with you to identify your potential risks and benefits
involved in using futures and/or options to hedge your price risks.
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