Welcome to Hedging Theory: the unit that explains why most commercial futures activity exists in the first place. Farmers, miners, food companies, and manufacturers do not usually trade futures to gamble on prices. They trade to protect a business they already run, and this unit lays out exactly how that protection works.
Exam Weight: Part 1 spans ~71% of the exam across Chapters 1-7 combined; the National Futures Association (NFA) does not publish per-unit weights.
Video Resources
What You'll Learn
In this unit, you'll cover:
- Risk Reduction: What a hedge actually is, why a hedger takes a futures position opposite to their cash-market position, and why the goal is price certainty rather than profit
- Short Hedging: How a business that already owns or produces a commodity sells futures to lock in a selling price and protect against falling prices
- Long Hedging: How a business that must buy a commodity later buys futures to lock in a purchase price and protect against rising prices
Why This Matters
Series 3 candidates are training to work with commercial clients: futures commission merchants, introducing brokers, commodity pool operators, and commodity trading advisors all deal with hedgers. Two ideas from this unit run through every hedging question on the exam:
- A hedger holds a real position in the physical (cash) market and uses futures to offset that position's price risk, so a loss on one side is roughly matched by a gain on the other
- The direction of the hedge is set by the cash position: own it and fear a price drop leads to a short hedge; need to buy it later and fear a price rise leads to a long hedge
The exam tests this reasoning as a concept, not as a set of facts to memorize. If you can name a hedger's cash position and what they fear, you can derive the correct futures action every time.
Let's start with the foundation: what a hedge is and how it reduces risk.