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Hedging
The origins of
hedging, oddly enough, are with gambling. In common usage,
it can mean many anything from that which protects against, or that
tends
to enclose or surround within.
What is hedging:
The use of hedging is generally a futures market strategy that aims
to limit exposure and protect against potential adverse business risks.
Simply
- there are similarities between hedging and purchasing ‘insurance’.
Though similarities that are quite loose, since both are simply used
to potentially lessen the force of a future unwanted occurance - since
hedging in commodities
unfortunately isn’t so clear cut.
Basically, hedging offsets a traders position by taking an opposite
position to the cash market. Both futures
and options contracts are
two methods of doing so. First, a trader wanting to sell a cash
commodity in times ahead will sell a futures contract (taking a first
position). A trader wanting to buy a cash commodity in times ahead will
buy a future contract. Next comes when the cash market transaction
occurs.
A hedger is either engaged in the ownership of a commodity or is looking to buy
or sell, and is anticipating that the price of the commodity may change.
Which is to say that hedgers are more directly involved with the commodity
itself. Large consumers of oil, and gas, like with transportation companies
and distributors, who take part in hedging where commodity prices can
be volatile, but for not only this reasons and the reasons
for hedging go on.
A comparison for a futures with a commodity
is commonly seen as a hedge
ratio.
Speculators, in contrast, don’t have much interest in the commodity
itself but rather look to glean a profit from any price fluctuations.
And they
assume the
risk which can be considerable indeed. Seen by some as money motivated, speculators
do contribute a lot in the way of liquidity and stability, nevertheless,
by their entering
into the trading markets.
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