Commodity Hedging

Abstract:

In this paper we will discuss about commodity hedging. The concept of hedging was developed in Japan during the 17th century. The practice of hedging helps the traders to avoid the risks associated with some frequently changing markets. Especially the farmers go more for commodity hedging as the corp. prices depend upon several things, like season, demand etc.

Commodity futures trading supports the concept of hedging, for which its popularity is increasing. The concept of commodity hedging can be explained with a suitable example given below.

The price of the corps depends upon the demand, supply and season. So to secure the corp. prices the farmers buy the commodity futures contracts. Finally, at the time contract maturity, those farmers then sell the products at a price mentioned in the futures contracts. Therefore, the farmers, who are eventually the commodity futures trader, can assume the corp. prices even in a frequently changing market.

The idea of hedging was originated in Japan. There the farmers bought the future contracts for their rice corps that had been stored in the warehouses. In the United States, the concept of commodity hedging developed in the 19th century.

However, commodity hedging is of three types, namely, production hedging, storage hedging, hedging expected purchases.

Through production hedging, the futures contracts are sold when the commodities start to grow and then, bought back when those commodities are ready for sell.

Storage hedging helps the traders to make profit from the futures market which will offset their losses from the money market.

Lastly, hedging expected purchases for commodity futures trading occurs when a trader wants to buy a material not right now but at some other time in future. In a frequently changing market the prices may get high or low at any point of time. So, to avoid any future hike, the traders buy long commodity futures contracts.