Basic principles of hedging

1. The concept of hedging:

Hedging refers to using the futures market as a place to transfer price risk , using futures contracts as a temporary substitute for buying and selling commodities in the spot market in the future, trading activities that involve buying commodities now in preparation for selling them later or insuring the price of commodities that need to be purchased in the future.

2. Basic characteristics of hedging:

The basic practice of hedging is to conduct equal quantities but opposite directions of the same type of commodities simultaneously in the spot market and the futures market. Trading activities, that is, while buying or selling physical goods, selling or buying the same amount of futures in the futures market. After a period of time, when the price changes cause profits and losses in spot trading, the profits and losses in the spot trading can be calculated by the futures trading. Losses are offset or covered. Thus, a hedging mechanism is established between "current" and "period", and between near-term and forward-term, so as to reduce price risks to a minimum.

3. The logical principle of hedging:

The reason why hedging can preserve value is that the main difference between futures and spot for the same specific commodity is that the delivery date is different. , and their prices are affected and restricted by the same economic factors and non-economic factors. Moreover, the requirement that physical delivery must be carried out when futures contracts expire makes the spot price and futures price converge, that is, when the futures contract When the contract is approaching the expiration date, the difference between the two prices is close to zero, otherwise there will be arbitrage opportunities. Therefore, before the expiration date, the futures and spot prices are highly correlated. In two related markets, reverse operations will inevitably have the effect of offsetting each other.