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Hedging

Hedging. Hedging is simply shifting the risk of price change in the cash market to the futures markets. This involves simply taking an opposite position in the cash market relative to the future position. Hedging Example:. FAPRI Iowa State University. Basis.

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Hedging

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  1. Hedging Hedging is simply shifting the risk of price change in the cash market to the futures markets. This involves simply taking an opposite position in the cash market relative to the future position. Hedging Example: FAPRI Iowa State University

  2. Basis Basis is simply defined as the difference between cash and futures prices. Example: On Jan.10, the cash corn price is $3.00/bu March futures contract is trading at $ 3.20/bu _____________________ March Basis = -$0.20/bu The negative sign attached to the basis indicates that the cash price is lower than the futures price. . FAPRI Iowa State University

  3. Improving Basis March corn futures $ 3.25 $ 3.25 $ 3.00 Cash corn $ 2.85 Jan. 1 Feb. 1 FAPRI Iowa State University

  4. Deteriorating Basis March corn futures $ 3.25 $ 3.25 Cash corn $ 2.85 $ 2.50 Jan. 1 Feb. 1 FAPRI Iowa State University

  5. Cause of Changing Basis • Supply and Demand • Protein supply • Conditions of crop • Transportation • Storage Availability. FAPRI Iowa State University

  6. Hedging • Hedging shifts the risk of absolute or total price movement to basis movements. • An element of risk still still exists with all hedge. • Types of Hedges: • Short Hedges: It is used to protect against declining value of the cash position. • Long Hedges: It is used to protect against increasing values of the cash position. FAPRI Iowa State University

  7. Computing Net Hedge Prices • Short hedge: need to calculate net hedge selling price (NHSP). • NHSP=CP+FP • Long hedge: need to calculate net hedge buying price (NHBP) • NHBP=CP-FP FAPRI Iowa State University

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