Quick Answer
One hedging framework works across every futures market: net price equals the initial futures price plus the ending basis (cash price minus futures price). Each market has a natural short hedger (a seller fearing a price drop) and a natural long hedger (a buyer fearing a price rise), and settles by physical delivery or cash settlement.
This unit is a market tour. The point is not new math, it is seeing that the same short-hedge and long-hedge logic already covered in this chapter carries into grains, cattle, metals, energy, Treasuries, currencies, and stock indices without changing.
The One Framework Behind Every Market
Before the catalog, lock in the two ideas every row below reuses. Nothing here is market-specific; it is the whole reason a single unit can cover eleven different markets at once.
The net-price formula is identical in every market. Whatever the underlying, a hedger's effective price is the futures price locked in at the start plus wherever the basis lands at the finish:
where the basis is the cash (spot) price minus the futures price, and the ending basis is that difference at the moment the hedge is lifted. Only the underlying and how the basis is quoted change from market to market. The arithmetic does not.
The hedger direction is set by the future cash transaction, never by the market. The rule is the same one from this chapter's short-and-long-hedging material:
- Natural short hedger (a seller): already owns or will produce the commodity and plans to sell it, so it fears a price decline and sells futures.
- Natural long hedger (a buyer): will need to buy the commodity later, so it fears a price rise and buys futures.
Think of it this way: the futures leg never asks what the commodity is. It asks one question: will this hedger end up a seller or a buyer? A future seller sells futures; a future buyer buys futures. Corn, copper, crude oil, or the euro, the question is the same and so is the answer.
Exam Tip: Gotchas
- A financial hedger protects a rate or a price level, not a stored commodity. A bond-portfolio manager, a short-term-rate hedger, and a stock-fund manager are hedging interest-rate risk, interest-rate risk, and broad equity-price risk, in that order. If an answer treats a Treasury or stock-index hedge as protecting the price of a warehoused good, it has the wrong kind of risk.
- Same formula, every market. A short hedge in cattle, cotton, or copper is computed exactly like the grain-producer example from this chapter's hedging calculations; a long hedge in currencies or energy is computed exactly like the processor example. A market you have never seen does not need a new procedure.
The Market Catalog: Physical-Delivery Markets
These are the markets where a real physical (or, for Treasuries, a real cash security) changes hands if the position is held into delivery. Because a genuine spot price exists, they have a true cash-versus-futures basis that narrows toward zero as delivery nears (convergence), and the transportation and deliverable-grade adjustments from this chapter's basis material apply.
| Market | Representative contract | Natural short hedger (seller) | Natural long hedger (buyer) | Price risk offset |
|---|---|---|---|---|
| Grains | Corn, wheat, soybeans | Farmer or grain elevator holding inventory to sell | Processor, feed mill, or exporter needing to buy | Crop price falling before sale, or rising before purchase |
| Livestock (live cattle) | Live cattle | Cattle rancher selling finished animals | Meat packer buying animals | Livestock price falling before sale, or rising before purchase |
| Foodstuffs (softs) | Coffee, sugar, cocoa, cotton | Grower selling the crop | Roaster, refiner, or manufacturer buying the input | Crop price falling before sale, or input cost rising before purchase |
| Metals | Gold, silver, copper | Miner, refiner, or dealer holding metal to sell | Jewelry or industrial fabricator buying metal | Metal price falling before sale, or rising before purchase |
| Energy | Crude oil (West Texas Intermediate, WTI), natural gas (Henry Hub) | Oil or gas producer selling output | Refiner, utility, or airline buying fuel | Energy price falling before sale, or rising before purchase |
| Lumber | The deliverable lumber contract | Sawmill selling finished lumber | Homebuilder or distributor buying lumber | Lumber price falling before sale, or rising before purchase |
| T-Notes / T-Bonds | Treasury note and bond futures | Portfolio manager or dealer fearing a yield rise on holdings | Investor expecting to buy bonds and fearing a yield fall | Long-term interest-rate risk: rising yields cut bond prices |
| T-Bills | 90-day Treasury bill futures | Borrower or issuer fearing a rise in short-term rates | Lender or investor fearing a fall in short-term rates | Short-term interest-rate risk on money-market funding |
| Currencies | Euro, British pound, and other foreign-exchange (FX) futures | Exporter that will receive foreign currency, so it sells it forward | Importer that will pay in foreign currency, so it buys it forward | Exchange-rate risk before settlement |
A few of these settle a security or a currency rather than a warehoused good, so the delivery mechanics are worth a closer look:
- Grains, livestock, softs, metals, and energy deliver the physical commodity itself. For grains, the deliverable instrument is a warehouse receipt evidencing ownership of the stored commodity.
- Treasury note and bond futures deliver an eligible cash Treasury from a defined delivery basket. The short chooses which qualifying issue to hand over and will pick the cheapest-to-deliver (CTD) one, the issue that costs the least to deliver against the contract.
- T-bill futures deliver a 90-day Treasury bill. This is an older, less-active money-market contract, but it still shows up on the exam.
- Currency futures exchange the actual currencies on the delivery date: the short delivers the named foreign currency and receives dollars.
Exam Tip: Gotchas
- Livestock is not uniformly one settlement type. Live cattle is physically delivered, but lean hogs and feeder cattle are cash-settled (they appear in the next table). Do not assume every agricultural contract is physically delivered just because grains are.
- Energy has both a physical benchmark and financial look-alikes. The headline West Texas Intermediate (WTI) crude and Henry Hub natural gas contracts are physically delivered, but cash-settled financial variants of the same size also trade. When a question names the benchmark contract, it is the physically delivered one.
- The short picks the cheapest-to-deliver Treasury. In T-Note and T-Bond futures the seller holds the choice of which basket-eligible issue to deliver and rationally delivers the CTD. The long does not choose.
The Market Catalog: Cash-Settled Markets
These markets settle in cash to a reference index or rate. Nothing is ever delivered, so at expiration the futures price is driven to the index value rather than to a local spot price. A basis still exists (the gap between the hedger's own portfolio or rate and the index), but it tracks an index, not a store-and-deliver spot.
| Market | Representative contract | Natural short hedger (seller) | Natural long hedger (buyer) | Price risk offset |
|---|---|---|---|---|
| Livestock (cash-settled) | Lean hogs; feeder cattle | Hog producer or backgrounder selling animals | Feedlot or packer buying animals | Livestock price falling before sale, or rising before purchase |
| 3-month SOFR | Short-term rate futures on the 3-month Secured Overnight Financing Rate (SOFR) | Borrower or issuer fearing a rise in short-term rates | Lender or investor fearing a fall in short-term rates | Short-term interest-rate risk on money-market funding |
| Municipals | Municipal bond index futures | Municipal dealer holding inventory, or a portfolio fearing a yield rise | Portfolio manager expecting to buy munis and fearing a yield fall | Interest-rate risk on a municipal portfolio |
| Stock indices | E-mini S&P 500 and other equity-index futures | Fund holding equities and fearing a market decline | Manager expecting an inflow and fearing the market rises first | Broad equity-price (market) risk on a stock portfolio |
Think of it this way: picture the two ends of the livestock business. A finished steer can actually be trucked to a delivery point, so live cattle delivers physically. A pen of feeder calves or a barn of hogs is far messier to deliver on a fixed date, so those settle to a published index instead. The hedge still works; the finish line is just an index value rather than a loading dock.
Memory Aid: The cash-settled group is index-settled: stock indices, the SOFR index, the muni index, plus the two index-settled livestock contracts (lean hogs and feeder cattle). If it settles to an index, no truck and no bond ever shows up at delivery.
Exam Tip: Gotchas
- Cash-settled markets have no physical delivery, so convergence works to an index, not a spot price. Stock indices, 3-month SOFR, cash-settled municipals, lean hogs, and feeder cattle all settle in cash to a reference index or rate. An answer claiming a stock-index or SOFR hedger takes or makes delivery of the underlying is wrong; there is nothing to deliver.
- The stock-index short hedger already owns the stocks. A fund manager hedging a portfolio against a market drop sells index futures (a short hedge) even though the manager is long the actual shares. The short refers to the futures leg, the same as it does in every commodity market.
- 3-month SOFR settles to a rate, and the older T-bill contract delivers a bill. Both hedge short-term interest-rate risk, but one is cash-settled to the Secured Overnight Financing Rate index and the other physically delivers a 90-day Treasury bill. Pair the settlement method with the right contract.