Help with Futures Market
AutoSave OFF DA S U wil hedging_intro_worksheet_forcanvas Q Search in Document Home Insert Draw Design Layout References Mailings Review View Share Comments ESE Times New... 12A A Aa A B I Uab X, x? Ave A E E SE OB AaBbCcDdE Normal AaBbCcDdE AaBbCcDc AaBb CcDdEt AaBb No Spacing Heading 1 Heading 2 Title AaBb CcDdE Subtitle AaBbCcDdEt S ubtle Emph... AaBbCcDdEx Emphasis Paste Styles Pane Setup It is May and you are a cotton farmer. You currently have cotton planted and you expect to harvest 50,000 lbs of cotton in October. The current price of cotton is $0.62/lb. You generally sell your cotton directly to your local yarn spinner. You have a long position in the cash market. A long position means that own actual, physical crop. Ownership can be either current inventory (e.g. in an elevator) or expected production - you own your expected production. If the price goes up between now and October, you are happy because you made money by not selling cotton now. If the price goes down, you should have sold cotton now. The problem was that you didn't have cotton to sell - you only had expected harvest. Since you are worried about a lower price in October, you have 3 strategies to have more confidence about the price that you will get in October: 1) Store cotton until a later time than October. 2) Forward contract - you and the spinner agree that you will deliver your harvest to them for a certain price. This locks you into delivering to that spinner. 3) Hedging with futures contracts. This worksheet will go over how hedging with futures works. Cash market Recall that the futures market and cash market are two distinct markets. Futures markets are markets for futures contracts, and the cash market is the market for (current or future) physical commodities. Forward contracts therefore are cash market transactions. Let's look at the cash market position of a cotton farmer from May to October. In May you are long in the cash market and the price is $0.62. In October the price has fallen by $0.2, and you sell to your local spinner at that price. Once you agree to sell, you now have a short position in the cash market. Write down your position in the cash market and the price for October below and calculate the gain or loss (per lb) relative to May's price. Position and price: Cash | May Long $0.62 October Short $0.42 Gain (+) or loss (-) $0.20 Page 1 of 3 882 words x English (United States) Focus E E . - - + 140% AutoSave OFF DA S U wil hedging_intro_worksheet_forcanvas Q Search in Document Home Insert Draw Design Layout References Mailings Review View Share Comments AaBb CcDdE Subtitle AaBbCcDdEt S ubtle Emph... AaBbCcDdEx Emphasis Paste Styles Pane Times New... 12A A Aa A ESE E AaBbCcDdE AaBbCcDdE AaBbCcDc AaBb CcDdEt AaBb B I Uab X, x? Ave A E SE OB Normal No Spacing Heading 1 Heading 2 Title Futures market Hedging uses a futures market position as a temporary substitute for a cash market position. Recall that almost no futures contracts result in delivery. Here we will only look at futures positions that do not result in delivery. Thus, the hedger uses two separate markets to provide a more stable net price - i.e. a more stable price when averaging the gains and losses from the two distinct markets. The hedger does not use futures market positions as forward contracts - they do not use futures contracts to establish a price for future delivery to the CME Group. To hedge, you take an opposite position in each market. So if you are long in the cash market, you take a short position in the futures market and vice versa. The steps of hedging are as follows: 1. Place a hedge by buying/selling the appropriate number of futures contracts 2. Unwind the hedge by simultaneously: a. Offsetting your futures market position. This is called lifting the hedge. b. Take the opposite position in the cash market. Thus you buy or sell physical cotton. Let's go through these steps for you as a cotton farmer. Assume for the moment that the cash and futures prices are both $0.62. By October, the cash and futures prices both decreased by $0.2. One cotton futures contract is for 50,000 lbs - exactly what you expect to harvest. 1. You are long in the cash market in May, so you place a hedge by selling one October futures contract (take a short position in the futures market). Fill out the first row of the futures column with your position and the price at which you took this position. 2. In October, you unwind your hedge by first buying one October futures contract at the new price. Fill in the second row under Futures with your position and the price at which you took this position. 3. To finish unwinding your hedge, you then sell your cotton to the local spinner at the October price. This results in a short cash market position. Record this under the second row of the Cash column. Position and price: Cash Futures May October Gain (+) or loss (-) Net price - Page 2 of 3 882 words x English (United States) O Focus EE E - - + 137% AutoSave OFF DA S U wil hedging_intro_worksheet_forcanvas Q Search in Document Home Insert Draw Design Layout References Mailings Review View Share Comments ESE Times New... 12A A Aa A B I Uab X, x? Ave A E E SE OB AaBbCcDdE Normal AaBbCcDdE AaBbCcDc AaBb CcDdEt AaBb No Spacing Heading 1 Heading 2 Title AaBb CcDdE Subtitle AaBbCcDdEt S ubtle Emph... AaBbCcDdEx Emphasis Paste Styles Pane Setup It is May and you are a cotton farmer. You currently have cotton planted and you expect to harvest 50,000 lbs of cotton in October. The current price of cotton is $0.62/lb. You generally sell your cotton directly to your local yarn spinner. You have a long position in the cash market. A long position means that own actual, physical crop. Ownership can be either current inventory (e.g. in an elevator) or expected production - you own your expected production. If the price goes up between now and October, you are happy because you made money by not selling cotton now. If the price goes down, you should have sold cotton now. The problem was that you didn't have cotton to sell - you only had expected harvest. Since you are worried about a lower price in October, you have 3 strategies to have more confidence about the price that you will get in October: 1) Store cotton until a later time than October. 2) Forward contract - you and the spinner agree that you will deliver your harvest to them for a certain price. This locks you into delivering to that spinner. 3) Hedging with futures contracts. This worksheet will go over how hedging with futures works. Cash market Recall that the futures market and cash market are two distinct markets. Futures markets are markets for futures contracts, and the cash market is the market for (current or future) physical commodities. Forward contracts therefore are cash market transactions. Let's look at the cash market position of a cotton farmer from May to October. In May you are long in the cash market and the price is $0.62. In October the price has fallen by $0.2, and you sell to your local spinner at that price. Once you agree to sell, you now have a short position in the cash market. Write down your position in the cash market and the price for October below and calculate the gain or loss (per lb) relative to May's price. Position and price: Cash | May Long $0.62 October Short $0.42 Gain (+) or loss (-) $0.20 Page 1 of 3 882 words x English (United States) Focus E E . - - + 140% AutoSave OFF DA S U wil hedging_intro_worksheet_forcanvas Q Search in Document Home Insert Draw Design Layout References Mailings Review View Share Comments AaBb CcDdE Subtitle AaBbCcDdEt S ubtle Emph... AaBbCcDdEx Emphasis Paste Styles Pane Times New... 12A A Aa A ESE E AaBbCcDdE AaBbCcDdE AaBbCcDc AaBb CcDdEt AaBb B I Uab X, x? Ave A E SE OB Normal No Spacing Heading 1 Heading 2 Title Futures market Hedging uses a futures market position as a temporary substitute for a cash market position. Recall that almost no futures contracts result in delivery. Here we will only look at futures positions that do not result in delivery. Thus, the hedger uses two separate markets to provide a more stable net price - i.e. a more stable price when averaging the gains and losses from the two distinct markets. The hedger does not use futures market positions as forward contracts - they do not use futures contracts to establish a price for future delivery to the CME Group. To hedge, you take an opposite position in each market. So if you are long in the cash market, you take a short position in the futures market and vice versa. The steps of hedging are as follows: 1. Place a hedge by buying/selling the appropriate number of futures contracts 2. Unwind the hedge by simultaneously: a. Offsetting your futures market position. This is called lifting the hedge. b. Take the opposite position in the cash market. Thus you buy or sell physical cotton. Let's go through these steps for you as a cotton farmer. Assume for the moment that the cash and futures prices are both $0.62. By October, the cash and futures prices both decreased by $0.2. One cotton futures contract is for 50,000 lbs - exactly what you expect to harvest. 1. You are long in the cash market in May, so you place a hedge by selling one October futures contract (take a short position in the futures market). Fill out the first row of the futures column with your position and the price at which you took this position. 2. In October, you unwind your hedge by first buying one October futures contract at the new price. Fill in the second row under Futures with your position and the price at which you took this position. 3. To finish unwinding your hedge, you then sell your cotton to the local spinner at the October price. This results in a short cash market position. Record this under the second row of the Cash column. Position and price: Cash Futures May October Gain (+) or loss (-) Net price - Page 2 of 3 882 words x English (United States) O Focus EE E - - + 137%
