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Hedging with Futures and Options

 

The No Nonsense Guide to Buying and Selling 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.

 

The No Nonsense Guide to Buying and Selling Options

 

 

 

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The information presented in this commodity futures and options site is not investment advice and is for informational purposes only. No guarantees are being made to its accuracy or completeness. This information can be considered a solicitation to enter into a derivatives trade. Investing in futures and options carries substantial risk of loss and is not suitable for some people. Past or simulated performance is not indicative to future results.