Futures

HEDGING, SPECULATION, AND ARBITRAGE

 Futures
 Hedge
 use futures to reduce risk on an existing position

 Speculate
 use futures to take on risk in the hope of making a profit

 Arbitrage
 Use the difference between spot and futures prices to
generate risk-free profit
 Existing Risk: Long soybeans
Income

$2,40,000

$2,30,000

$2,20,000

$2,10,000

$2,00,000

$1,90,000

$1,80,000
360 380 400 420 440 460 480
Price (Soybeans Spot)
 Hedge
 An investment that offsets this risk
 Short soybeans

 Short Soybean futures

 Hedge Strategy
 If soybean prices increase
 Long Spot J

 Short Futures L K
 If soybean prices decrease
 Long Spot L

 Short Futures J K
 Hedge Strategy
 Use November Futures

October ?
plant Spot risk harvest

Offsetting futures risk Lift November

Set Hedge contracts
Hedge deliver
 Set the Hedge
 George sets the hedge in April
 Spot price: $4.20/bu

 Futures price: 431

 Basis (spot-futures) = -11¢

 Set the Hedge
 Set the hedge in April

October ?
$4.20 harvest

Lift November
431 Hedge contracts
deliver
-11¢
 Set the Hedge
George Q. Farmer
Hedge is set

Long Position (spot)

Short Position
(futures)
Income

$2,50,000

$2,00,000
Long
Position

$1,50,000

$1,00,000

$50,000
Short Position

$0
360 380 400 420 431 440 460 480
-$50,000
Price (Soybeans Spot)