Table of Contents

Commercial Hedger: Meaning, Example, FAQs

By

澳洲幸运5官方开奖结果体彩网:James Chen

Updated July 30, 2022

Reviewed by Akhilesh Ganti

Fact checked by

Daniel Rathburn

What Is a Commercial Hedger?

A commercial hedger is an organization that uses derivatives such as futures contracts to lock in the price🍌 of specific commodities it uses in running its business. A commodity is a necessary good reওquired for the production of a good or service.

Thus, a food manufacturer may practice commercial hedging if it purchases co𒆙mmodities such as sugar or wheat or which it needꦆs to produce its products. Electrical component manufacturers may hedge copper which it uses in production.

Key Takeaways

A commercial hedger utilizes the derivatives or securities markets in order to lock in prices for the goods that they produce or else consume in the production process.
Commercial hedging is a method of normalizing operating expenses for a company in an attempt to control commodity price risk.
Commercial hedging allows firms to reduce their exposure to market risk, making them agnostic to whether the price of a commodity rises or falls once the hedge has been established.
Airlines, for example, may purchase oil or gas futures in anticipation of future flights, or a breakfast cereal maker will purchase wheat or corn futures in light of future cereal demand.
Oil refineries, on the other hand, may sell oil futures while wheat or corn farmers will sell agricultural futures ahead of their harvests.

Understanding Commercial Hedgers

An entity uses commercial hedging as a method of normalizing operating expenses as they attempt to control 澳洲幸运5官方开奖结果体彩网:commodity price risk and more accurately predict its production costs. A hedge is like an insurance policy where an investment helps to reduce the risk of adverse price movements in an asset. Commercial hedgers deal in futures contract💟s to manage specific price risks.

In contrast, 澳洲幸运5官方开奖结果体彩网:non-commercial traders are those investors who use the fꦆutures marketplace for commodity speculation. Speculation is the act of trading in an asset or conducting a financial transaction that has a significant risk of losing most or all of the initꦚial outlay with the expectation of a substantial gain.

Fast Fact

There are 🎐different types of hedgers: buy-side hedgers, sell-side hedgers, and merchandisers.

The Commodity Futures Trading Commission (CFTC), a U.S. government agency, sets parameters to classify traders to set limits on trading and position size which differ between commercial and noncommercial traders. In fact, the Commission’s weekly 澳洲幸运5官方开奖结果体彩网:Commitments of Traders report lists the number of open fut🍸ures contracts for both commercial and noncommercial traders.

A com𓃲pany may be considered a commercial hedger for one commodity, but not for others. A candy manufacturer classified as a commercial hedger for cocoa or sugar would not be classified for commer𓃲cial hedging of aluminum, heating oil, or other commodities.

Example of a Commercial Hedger

Futures contracts are used both for speculative trading and for hedging. The deals are traded on various exchanges and have a price basis for the delivery of a specific commodity amount 𒐪at a pre-defined future date. These futures prices may vary from the current spot price of the commodity. The spot price is t🃏he current cost of the commodity in the open market.

For example, the spot price of copper may currently be $3.12 per pound. An electrical wiring company that uses copper in its production may set its prices based on that cost. However, the price may rise in the future. This rise in price forces the company to either make less profit or to raise their product's price.

Important

Hedge funds are some of the largest 澳洲幸运5官方开奖结果体彩网:speculators, making many of the same types of trades as hedgerꦛs, but purely for profit as opposed to mitigating risk.

Conversely, a falling price may cause the company's product to be higher than competitors, costing them market share. To stabilize its price structure and lock in a price for copper it needs for future production the company could buy copper futures contracts.

Even though the spot price of copper may be $3.12 per pound, the price for future delivery is often higher to account for storage co𝐆sts. For example, the price for delivery might be $3.15 per pound for delivery in three months, $3.18 deliverꦬy in six months, $3.25 in one year, and so on.

Special Considerations

A commercial hedger may 澳洲幸运5官方开奖结果体彩网:diversify their contractℱs across multiple months to assure a set 💦price at specific future dates.

If the copper price falls below that of the futures contract, the business may sell its contract at a loss. Even taking a loss on the futures contract, the company was able to mitigate its risk against a rise in 澳洲幸运5官方开奖结果体彩网:raw material costs.

When the cop🌺per price rises, the electrical wiring company is not required to take physical delivery of the commodity but may sell the futures at a profit in the open marketplace. The company can buy or sell copper futures contracts on an ongoing basis as its needs change.

What Is a Hedge?

A hedge is a financial transaction or investment made by ♉a company or investor to reduce the impact of adverse price movements on their business or other investments. In short, a hedge is a measure taken to reduce risk by taking a position in the opposite position or offsetting position of a specific security.

What Are the Differences Between Hedgers and Speculators?

A hedger seeks to offset adverse price risk for a specific security by taking the opposite or offsetting position in another security. A hedger's goal is to reduce risk from price changes. A speculator, on the other hand, seeks to make a profit by price changes and takes positions in specific securities in order to do so.

What’s the Difference Between Hedging and Arbitrage?

Hedging seeks to reduce price risk by taking a position in an offsetting or opposite position from the primary invested security or product. The goal for a hedger is to reduce risk. Arbitrage seeks to make a profit fr♛om the temporary price differentials of the same product available on different markets.

Who Are the Hedgers in the Oil and Gas Markets?

The primary hedgers in the oil♊ and gas markets are the oil and gas producing companies. These companies seek to sell oil and gas for as high as they can, thereby making the most profits. Given that oil and gas prices fluctuate often based on a variety of factors, oil and gas producers seek to lock in higher prices by hedging their price risk. They can do this by investing in futures or options.

What Does De-Hedge Mean?

De-hedge refers to the process of closing a hedge. This involves trading out of a position that acted as a hedge for a security or product. De-hedging occurs if the hedge paid off or if the conditions in the market make tꦗhe position no longer worthwhile.

The Bottom Line

Hedging aims to reduce the risk of adverse price movements for securities or products sold by companies. Hedgers take positions in offsetting or opposite positi🦩ons to do so, primarily by investing in futures and options. Hedging ca🍎n greatly help minimize losses and keep profits high.

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