Long Hedge

What Is a Long Hedge?

A long hedge alludes to a futures position that is placed into with the end goal of price stability on a purchase. Long hedges are frequently utilized by manufacturers and processors to eliminate price volatility from the purchase of required inputs. These info subordinate companies realize they will require materials several times every year, so they enter futures positions to settle the purchase price consistently.

Hence, a long hedge may likewise be alluded to as an info hedge, a buyers hedge, a buy hedge, a purchasers hedge, or a purchasing hedge.

Seeing Long Hedges

A long hedge addresses a smart cost control strategy for a company that realizes it necessities to purchase a commodity later on and needs to lock in the purchase price. The actual hedge is very simple, with the purchaser of a commodity essentially entering a long futures position. A long position means the buyer of the commodity is making a bet that the price of the commodity will rise from here on out. Assuming the great rises in price, the profit from the futures position assists with offsetting the greater cost of the commodity.

Illustration of a Long Hedge

In a simplified model, we could expect that it is January, and an aluminum manufacturer needs 25,000 pounds of copper to produce aluminum and satisfy a contract in May. The current spot price is $2.50 per pound, however the May futures price is $2.40 per pound. In January the aluminum manufacturer would take a long position in a May futures contract on copper.

This futures contract can be estimated to cover part or the entirety of the expected order. Sizing the position sets the hedge ratio. For instance, on the off chance that the purchaser hedges a portion of the purchase order size, the hedge ratio is half. In the event that the May spot price of copper is more than $2.40 per pound, the manufacturer has profited from taking a long position. This is on the grounds that the overall profit from the futures contract assists offset the higher purchasing with costing paid for copper in May.

On the off chance that the May spot price of copper is below $2.40 per pound, the manufacturer assumes a small loss on the futures position while saving overall, because of a lower-than-expected to purchase price.

Long Hedges versus Short Hedges

Premise risk makes it truly challenging to offset all pricing risk, however a high hedge ratio on a long hedge will eliminate a ton of it. Something contrary to a long hedge is a short hedge, which safeguards the seller of a commodity or asset by locking in the sale price.

Hedges, both long and short, can be considered a form of insurance. There is a cost to setting them up, yet they can save a company a large amount in an adverse situation.