Hedging with Commodities Futures



I want to see if I can give you a slightly better explanation of how a farmer can use futures markets to lock in a price of a commodity I don't think I was very clear about it in class so perhaps this will be a little bit better of an explanation suppose that I'm a farmer and it's March now I'm growing corn and let's suppose that I anticipate that in July I will have 5,000 bushels 5,000 bushels of corn to sell but I don't have any corn to sell now now it's it turns out that right now in March the price of corn is five dollars a bushel if I had the corn to sell now I could sell it for $5 a bushel and that's called the spot price so the spot price of a corn right now in March is five dollars a bushel well if I had 25 if I had 5,000 bushels of corn now I could sell them for $25,000 but I don't and here's my problem I'm afraid that between now and July between March and July I'm afraid that the spot price of corn suppose I'm afraid it will decrease between now and July from five dollars to three dollars well then I wouldn't be able to sell my corn for five for $25,000 I would have to sell my 5,000 bushels of corn for $15,000 and so what can I do about that well I can go to the futures market and I can actually contract right now to sell corn in six months in in March April May June July four months four or five dollars a bushel I can sell a futures contract at five dollars a bushel so I'm going to sell a contract for 5,000 bushels of corn at five dollars a bushel so I'm gonna sell a contract for twenty five thousand dollars basically someone is promising to pay me five dollars a bushel or twenty five thousand dollars for five thousand bushels of corn in July so now let's see what happens suppose we get to July and indeed the spot price of corn in July in four months has gone down to three dollars well now I've grown 5,000 bushels of corn I have the five thousand bushels of corn now but if I go to sell the five thousand bushels of corn I have to sell them at three dollars a bushel because that's the spot price of corn so indeed my fear is realized I was afraid I would be only only be able to sell the corn for fifteen thousand dollars and in fact that's all I can sell it for sell the corn for fifteen thousand dollars aha but now I can go back to the futures market and I have this contract and this contract says I can sell 5,000 bushels of corn for five dollars a bushel now I don't actually enforce the contract when it comes to July and the contract is about to come due corn is only worth three dollars a bushel so my July corn contract is now only selling for three dollars a bushel so that same contract that I've sold in March is now only worth $15,000 well uh-huh I sold the contract for $25,000 now I have to buy it back but I buy it back for $15,000 which is $10,000 less than I sold it for and now from the from the repurchase of the futures contract for buying something for $10,000 less than I sold it for I have a $10,000 profit on my futures contract so yes I was only able to sell the corn for $15,000 Bart I can add to that my $10,000 profit from the futures contract so effectively I have sold the corn plus the profit on my futures contract for $25,000 and that's the $25,000 that I could have gotten back in March when corn was selling for five dollars a bushel but I didn't have the corn to sell so this process is called hedging hedging it's March corn is selling for five dollars a bushel as a farmer I'm worried about the price going down and I'm perfectly happy to sell it for five dollars so I go to the futures market and I go ahead and say fine I'm selling it I won't deliver it till July but I'm selling it right now for five dollars a bushel for July delivery and then if the price does go down to three dollars I can buy back my contract for a less and make up for the difference between five dollars and three dollars that I sell the actual corn for so this is called hedging and this is really the original purpose of commodities futures markets I know it's a little bit of a difficult concept I'm kind of hoping that this explains it a little bit better to you and I'd very much appreciate if you just send me a quick email to let me know was this helped some or whether you're still lost and if you are lost I don't want you to worry too much about it because it's not something that that you have to understand perfectly for the class but but it's a nice thing to know if you can understand it so thank you for watching this you

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