For example, a farmer estimated that he would harvest 50 tons of soybeans in July this year. But he was worried that soybean prices would fall in July, so he decided to short 50 tons of soybean futures in July.
When shorting futures, he only needs to pay a small margin, which is basically equivalent to 8% to 15% of the value of 50 tons of soybeans. At this time, he has no cash income. However, from the second trading day, his trading account will fluctuate. If the soybean price drops, the corresponding cash will be added to his trading account, otherwise, the corresponding cash will be deducted. These changes are real.
The farmer can liquidate his short position at any time. However, before liquidation, the profit and loss of this position will be settled immediately. Generally speaking, in order to really play a hedging role, he will close his position in July. At this time, if the soybean price drops by X yuan per ton, his trading account will make a profit of 50x yuan. These profits just make up for the loss of his shrinking harvest. On the contrary, if the soybean rises, his trading account will lose money accordingly, and these losses will be made up by the appreciation of the harvest. This is hedging.