The key to hedging lies in the correlation between futures and spot prices. The higher the correlation between futures and spot prices, the smaller the basis risk and the better the hedging effect. Therefore, when choosing futures contracts, the closer the relationship with spot commodities, the better. In other words, when choosing futures contracts, hedgers should choose contracts with smaller basis.

2. Choice of expiration month of futures contract

When the hedger is not sure when to dispose of the spot goods, or the time when the hedger disposes of the spot goods is not exactly the same as the expiration month of the futures contract, the hedger usually has two choices:

(1) Select the futures contract in the latest month, then write off this part before the contract expires, and then convert it to the futures contract in the next expiration month, and so on until it is consistent with the time for handling the spot;

(2) Choose a contract that is close to the spot time that may be processed, but the expiration month is far away, without too many futures contract conversions.

The advantage of the first scheme is that the futures contracts in recent months are usually highly correlated with the spot market, and the hedging effect is better. Moreover, in recent months, the trading volume of futures contracts is usually larger, the liquidity is better, and it is more convenient for hedgers to trade, but the disadvantage is that more switching costs and strict procedures must be paid. The advantage of the second scheme is to reduce the transaction cost, but the correlation between the forward month futures contract and the spot li field is usually small, and the market liquidity is also low. Therefore, generally speaking, the hedging effect of futures contracts in recent months is relatively good.

If you know when to deal with the spot, you must strictly follow the principle of hedging.

3. Timing of hedging

The timing of hedging entry refers to the question of when to enter the market to buy and sell futures and the number of transactions. If the goal of hedging is to maximize utility (or profit), then he does not need to hold futures contracts at any time, but only needs to enter the market to write off when he thinks the market trend will be unfavorable to him. This kind of hedging is generally called selective hedging.

But unfortunately, no one can correctly predict when the market will go favorable and when it will go unfavorable, and no one can answer this question. Therefore, if investors don't want to take any risks, but just want to lock the risks in the spot market at a fixed level, then they should take continuous hedging operations.