Learn how to – Hedging Risks in the Commodity Market

Learn how to – Hedging Risks in the Commodity Market.

The effectiveness of financial management largely depends on the ability of companies to hedge their risks. Thanks to this, profits become more stable and, in general, the manageability of the company’s finances increases. Risk hedging is necessary not only for large companies but also for private investment activities. If you have not yet learned how to do this effectively, Payday Depot will help you cope with a difficult situation.

Main Hedging Strategies for Commodity Market

Insurance of various risks associated with doing business in one market by opening transactions in another is commonly called hedging. Hedging strategies are chosen on a case-by-case basis and may include the following.

Different Types of Derivatives

Risks can be transferred using derivatives. Buying or selling futures contracts or options will help to stabilize the future receipt of funds:

● Futures and forwards (swaps) help fix the price of the asset you are investing in at a certain point in the future. Futures can be bought and sold on exchanges, while forwards are negotiated off-exchange on an individual basis.

● Commodity options are designed to provide insurance against extreme changes in the value of a commodity. By trading options, you can also get additional benefits due to their early sale.

Calendar Spreads

This hedging instrument consists of two swaps:

● one for purchase

● the other is for sale

In the case of oil hedging, this will be one swap for the purchase of crude oil and the second — for the sale of finished petroleum products. This tool is called the crack spread.

Thus, the risks of a trader making investments in a highly volatile market are reduced.

Which Industries Are Most Exposed to Price Risk?

In the commodity market, investments in the following sectors are most vulnerable, and therefore require hedging:

● Agriculture is quite unpredictable due to changes in weather and climate, diseases of plants, animals, and birds

● The oil industry, where the dynamics of supply and demand can change prices by 5 times

● Precious metals, the use of which in a particular industry can sharply increase their price, followed by the same sudden decline

Hedging Costs You Should Consider

But hedging has a certain price. In order to implement the chosen strategy, the company or individual investor needs to allocate part of its working capital to its implementation. Therefore, it is first necessary to carefully calculate all the risks before applying a definite hedging strategy:

● For example, if you buy raw materials in one country to transport them to a distant place, the time spent on transportation can work against your business.

● And if the time for transportation is insignificant, then the risks, respectively, decrease.

Fluctuations in prices for goods, including such significant ones as energy carriers or agricultural products, are significantly influenced by the geopolitical situation. Given today’s real and potential military conflicts, it is possible to predict sharp jumps in prices for these goods in the near future. Therefore, risk hedging becomes more relevant than ever. Learn various hedging strategies in the commodity market and successfully apply them to improve the efficiency of your business.