Buying Hedge

What Is a Buying Hedge?

A buying hedge is a transaction a company participated in manufacturing or production will embrace to hedge against potential increases in the price of the real materials underlying a futures contract. This strategy is likewise realized by many names including a long hedge, input hedge, purchaser's hedge, and purchasing hedge.

The managers of a manufacturing company might utilize a buying hedge to lock in the price of a commodity or asset they realize they will require for future production. The buying hedge permits the managers to safeguard the company against the price volatility that could happen in the underlying asset from the time they start the buying hedge to the time they really need the commodity for production. A buying hedge is part of a risk management strategy that assists companies with overseeing variances in the price of production inputs.

Figuring out Buying Hedges

A buying hedge could appear as a manufacturer purchasing a futures contract to safeguard against expanding prices of the underlying asset or commodity. A futures contract is a legal agreement to purchase or sell an asset or commodity at a specific price at a foreordained future date.

The purpose of a hedge is to safeguard; hence, a hedge position is embraced to reduce risk. Now and again, the one putting the hedge claims the commodity or asset, while different times the hedger doesn't. The hedger makes a purchase or sale of the futures contract to substitute for an eventual cash transaction. Investors may likewise utilize a buying hedge on the off chance that they anticipate having a future requirement for a commodity, or on the other hand assuming that they plan on entering the market for a particular commodity sooner or later.

Benefits of a Buying Hedge

Many companies will utilize a buying hedge strategy to reduce the uncertainty associated with future prices for a commodity they need for production. The business will endeavor to lock in the price of a commodity like wheat, hoards, or oil.

Investors could utilize a buying hedge in the event that they hope to buy a certain amount of the commodity later on, yet are stressed over price vacillations. They can buy a futures contract to buy the commodity at a fixed price later. If the spot price of the underlying asset moves toward a path more beneficial for the holder, they can sell the futures contract and buy the asset at the spot price.

A buying hedge may likewise be utilized to hedge against a short position that has previously been taken by the investor. The objective is to offset the investor's loss in the cash market with a profit in the futures market. The risk of utilizing the buying hedge strategy is that assuming the price of the commodity drops, the investor might have been exceptional off without buying the hedge.

Buying hedges are speculative trades and carry the risk of being on some unacceptable side of the market, in which case the investor could lose some or the entirety of their investment.

Illustration of a Buying Hedge

Assume a large flour miller just marked a contract with a pastry shop that delivers different packaged breads, cakes, and baked goods. The contract calls for the flour miller to furnish the bread kitchen with a continuous supply of flour to be delivered on a foreordained schedule consistently.

The production managers for the miller work out their breakeven cost for flour production and find they must purchase wheat at $6.50 a bushel to break even. To satisfy the pastry kitchen's orders for flour and create a gain, the miller must pay under $6.50 per bushel. Presently, it's March and the price of wheat is $6.00 per bushel, and that means the miller will create a gain.

Be that as it may, the miller expects a spike in the price of wheat due to a prediction of hot, dry climate over the mid year, leading to a reduction in wheat production. To start a buying hedge against this conceivable price increase, the miller purchases long positions in September wheat futures and can lock in a price of $6.15 per bushel. Should the price of wheat soar as anticipated in September, the miller will actually want to offset this by gains made in the buying hedge.

Features

• Manufacturers use buying hedges to lock in the price of a commodity they will require sometime in the not too distant future for production.
• A buying hedge is a transaction that safeguards an investor or company against conceivable price increases in the commodities or assets underlying a futures contract.
• Investors will utilize a futures contract as a buying hedge that permits them to buy a certain amount of a commodity at a fixed price from here on out.
• Buying hedges are part of an overall strategy that helps companies in dealing with the costs of their production inputs.