A selling hedge is also called a short hedge. Selling hedge means selling a futures contract to hedge.
Benefits of selling strategy:
- To cover the price of finished products.
- To protect inventory not covered by forward sales.
- To cover the prices of estimated production of finished products.
They are merchants and processors who acquire inventories of the commodity in the spot market and who simultaneously sell an equivalent amount or less in the futures market. The hedgers in this case are said to be long in their spot transactions and short in the futures transactions. It is a hedging strategy used by manufacturers and producers to lock in the price of a product or commodity to be delivered some time in the future. Hence, it is also known as the output hedge. For instance,
In March, a wheat farmer is planning to plant 100000 bushels of wheat, which will be ready for harvesting by late August and delivery in September. The farmer knows from past years that the total cost of planting and harvesting the crops is about $6.30 per bushel.
At that time, September Wheat futures are trading at $6.70 per bushel, and the wheat farmer wishes to lock in this selling price. To do this, he enters a short hedge by selling some September Wheat futures.
With each Wheat futures contract covering 5000 bushels, he will need to sell 20 futures contracts to hedge his projected 100000 bushels production.
By mid-August, his wheat crops are ready for harvesting. However, the price of wheat have since fallen and at the local elevator, the price has dropped to $6.20 per bushel. Correspondingly, prices of September Wheat futures have also fallen and are now trading at $6.33 per bushel.
