Deep Dive · Futures · Lesson 6
Hedging
with Futures
Big Idea
Hedging is the original purpose of futures — removing price risk by locking in a price today. A hedger takes a futures position opposite to their real-world exposure, so a loss on one side is offset by a gain on the other.
- A producer fears prices falling before they can sell.
- A consumer fears prices rising before they can buy.
Hedging is about certainty, not profit.
What Hedging Means
To hedge is to offset an existing risk. You already have exposure to a price in the real world, so you take an opposite position in futures to cancel it out.
- Someone who will sell an asset later fears lower prices → goes short futures.
- Someone who will buy an asset later fears higher prices → goes long futures.
Whatever the hedger loses in the real world, the futures position gains — and vice versa. The two move in opposite directions, and together they hold the net result roughly still.
Producer
Short Hedge: A Producer
A corn farmer will harvest 5,000 bushels — exactly one corn futures contract. Corn futures today trade at $5.00 per bushel. Fearing that prices will fall before harvest, the farmer sells one corn future at $5.00.
| Corn Price at Harvest | Sells Crop For | Short Future P&L | Net Result |
|---|---|---|---|
| $4.00 | $20,000 | +$5,000 | ~$25,000 (≈ $5.00/bu) |
| $5.00 | $25,000 | $0 | $25,000 (≈ $5.00/bu) |
| $6.00 | $30,000 | −$5,000 | ~$25,000 (≈ $5.00/bu) |
Whichever way corn moves, the farmer nets about $5.00 per bushel — the price is locked.
Consumer
Long Hedge: A Consumer
An airline will need 1,000 barrels of fuel — roughly one crude oil contract. Crude today trades at $75. Fearing that the price will rise before it buys, the airline buys one crude future at $75.
| Oil Price Later | Pays at Market | Long Future P&L | Net Cost |
|---|---|---|---|
| $65 | $65,000 | −$10,000 | ~$75,000 |
| $75 | $75,000 | $0 | $75,000 |
| $85 | $85,000 | +$10,000 | ~$75,000 |
The airline locks an effective ~$75 per barrel either way.
A Hedge Removes Both Sides
There is a tradeoff hiding in those tables. Locking a price removes the bad outcome — but it removes the good one too. If the feared move never happens, the hedger gives up the favourable move they would otherwise have enjoyed.
Look again at the farmer: if corn rises to $6.00, the crop sells for $30,000 — but the short future loses $5,000, dragging the net back to about $25,000. The upside was handed over in exchange for certainty. That is the price of a hedge, and for a business that needs a predictable budget it is usually worth paying.
Hedges Are Rarely Perfect
In reality, contract sizes, timing, and the gap between futures and spot prices mean a hedge is almost never exact. A small leftover risk remains — called basis risk — which is the subject of the next lesson.
Interactive Checks
Check 1 of 3
A wheat farmer wants to lock in a selling price for a crop not yet harvested.
Which hedge fits?
Check 2 of 3
An airline wants to lock in the price it will pay for fuel.
Which hedge fits?
Check 3 of 3
A hedger opens a futures position opposite to their real-world exposure.
What is the main goal of hedging?
Common Beginner Mistakes
- ❌ Thinking hedging is a way to make profit. A hedge removes price risk; it is not a bet designed to win.
- ❌ Forgetting a hedge caps upside as well as downside. Locking a price gives up the favourable move too.
- ❌ Mismatching the hedge to the real exposure. Over- or under-hedging leaves you with the wrong amount of risk.
- ❌ Assuming a hedge is perfect. Contract sizes and timing leave a small basis risk behind.
Quick Memory Tool
- Hedge = take the opposite futures position to your real exposure
- Producer (will sell) → short hedge
- Consumer (will buy) → long hedge
- A loss on one side is offset by a gain on the other
- Hedging buys certainty — and gives up the favourable move too
Next Lesson
Speculation and Basis — speculators take on the risk hedgers want to shed, and provide liquidity. Next we look at them, and at “basis” — the gap between futures and spot prices that closes at expiration.