Hedging & FuturesPresented by Jonathan Truong

Agenda• Futures Review• What is Hedging• What to Consider• Wheat Example• Gas Example

Review on Futures• Forward contract• Many players• Make/take deliveries• Speculating prices• Open/close positions• Clearing house

Hedging• What is hedging?• Future contracts to limit exposure to commodity prices• Used to offset natural risk exposure on profits and expenses• Not meant for income production mechanism

Things to Consider• Hedging with future contracts• Maturity • Units of commodity per contract• How many contracts you need• Initial margins to initiate positions• Maintenance margin

Wheat Contract

Farmer• Contract – sell (short) 4• Contract = 50,000 bushels

@$4.50/bushel • Maturity is 1 month/contract• MM is 10%

Notional• 4(50,000*4.5) = $900,000• MM = .10*90,000 = $9,000

Baker• 4 contracts/mo

Scenarios• month 1• Bumper crop• 4(50,000*4.5) = $900,000• 10 contracts extra of bushels (no futures)

• Spot sell • Assume demand was low, @$4.4/bushel

Assume demand was high, @$4.7/bushel• Farmer savings in contracts

• 4(50,000(4.5-4.4)) = +$20,000 | 4(50k(4.5-4.7)) = -$40,000• Farmer loss/savings in extras (not in futures)

• 10(50,000(4.4-4.5)) = -$50,000 | 10(50k(4.7-4.5)) = +$100,000• Net delta -$30,000 +60,000

Scenarios

• Drought

• Able to deliver partial contract for that month/all/no futures• Spot deliver the rest @$5.70/bushel

Situation Margin Profit (delta)

Meet contract (benchmark future)

$900,000 ($240,000)

No futures $1,140,000 -

Delivery Company Example• 90,000 gallons of fuel• Hedge for next 3 months

• 2 contracts/month x 3mo• Margin is $68,850

Fuel Contract• 42,000 gallons• Initial margin

$11,475• MM $8,500

Exp. Information• Average price for a gallon: $3.50

What are the fuel savings?month 1 = 90,000($3.50 - $3.25) =$22,500month 2 = $45,000month 3 = $63,000

Gain from fuel savings = $130,000

Month Futures Prices

1 2.8974 3.25

2 2.8798 3.00

3 2.7658 2.80

• How much did you lose on your futures contracts?

month 1 = 84,000($2.6813 - $2.8974) = - $18,152.40month 2 = - $39,127.20month 3 = - $55,935.60

loss on future = -$113,215.20

Month Futures Closing Futures Price

1 2.8974 2.6813 3.25

2 2.8798 2.4140 3.00

3 2.7658 2.0999 2.80

Review Q.• Was this a good hedge?

References• "Hedge (finance)." Wikipedia. Wikimedia Foundation, 18 May 2013. Web. 22 May 2013.• "Introduction to Hedging with Futures." YouTube. YouTube, 18 Dec. 2011. Web. 23 May 2013.• Kuepper, Justin. "Speculating vs. Hedging With Futures Explained." Commodity HQ. N.p., 23 Dec.

2012. Web. 25 May 2013.• "What Is the Difference between Hedging and Speculation?" What Is the Difference between

Hedging and Speculation? N.p., 26 Feb. 2009. Web. 25 May 2013. <http://www.investopedia.com/ask/answers/06/hedgingversusspeculation.asp>.

• Wisner, Robert. "Principles of Hedging with Futures." MARKETING & UTILIZATION Cooperative Extension Service. Purdue University, May 2002. Web.

Questions?