Net Result of Hedge

This section builds the machine you will run for the rest of the chapter: add the two legs, respect the sign on the futures gain, and read the combined number. All grain figures here are in cents per bushel, the standard way these contracts are quoted.

The Two-Market Add-Up

A hedger always holds two positions at once: a cash (physical) position in the actual commodity and an offsetting futures position. The hedge's outcome is simply the sum of both.

• The futures leg is expected to gain roughly what the cash leg loses (and the other way around), so the two largely cancel. That is the whole point: the combined result is far steadier than either market alone.
• A hedge does not aim to make money on the futures leg. It aims to lock a price, so a loss on one leg is meant to be paid for by a gain on the other.

Futures gain or loss depends on which side the hedger is on:

• A short futures position sold first, so its profit is the initial futures price minus the buy-back price (sell high, buy back low is a gain).
• A long futures position bought first, so its profit is the sell price minus the initial buy price (buy low, sell high is a gain).

Think of it this way: the futures leg is a counterweight bolted onto your cash position. When cash sags, the counterweight rises by about the same amount, and when cash jumps, the counterweight drops. You are not trying to win on the counterweight. You are trying to keep the whole thing from tipping.

Exam Tip: Gotchas

• A hedge's net is the SUM of both legs, not the futures result alone. A common trap reports only the futures gain or loss and calls it the outcome. Always add the cash-market result to the futures-market result before you judge the hedge.

Worked Short Hedge (Producer)

A grain producer expects to sell cash grain later and fears a price drop, so the producer sells futures now to hedge.

• At hedge placement, futures trade at 440.
• Later, when the crop is ready, the local cash price is 410 and futures have fallen to 420.
• The producer sells the cash grain at 410 and buys back the futures at 420 to close the hedge.

• Cash at the lift landed 30 below the initial futures reference of 440, but the short futures gained 20, so the producer nets 430 instead of the bare cash 410. The hedge cushioned the decline.
• Basis cross-check: ending basis = cash minus futures = 410 minus 420 = -10 (10 under). Initial futures 440 plus ending basis (-10) = 430, matching the net exactly.

Exam Tip: Gotchas

• A "losing" futures position inside a hedge is normal, not a failed hedge. Here the futures leg gained, but when it is the cash side that gains, the futures leg shows a loss by design. The two are meant to cancel, so never grade a hedge on the futures leg alone.

Worked Long Hedge (Processor)

A food processor expects to buy cash grain later and fears a price rise, so the processor buys futures now to hedge.

• At hedge placement, futures trade at 440.
• Later, when the processor needs the grain, the local cash price is 470 and futures have risen to 465.
• The processor buys the cash grain at 470 and sells the futures at 465 to close the hedge.

• Cash rose to 470, but the long futures gained 25, which the processor applies against the higher cash cost, for a net cost of 445. Without the hedge, the processor would have paid the full 470.
• Basis cross-check: ending basis = 470 minus 465 = +5 (5 over). Initial futures 440 plus ending basis (+5) = 445, matching the net cost exactly.

Think of it this way: the producer and the processor are mirror images. The seller adds the futures gain to the cash sale to lift a low price up to 430; the buyer subtracts the futures gain from the cash purchase to pull a high price down to 445. Same counterweight, opposite direction.

Exam Tip: Gotchas

• The seller adds the futures gain to cash; the buyer subtracts it from cash. Mixing up the direction turns a helpful hedge into a nonsense number. Tie the sign to the side: the short hedger's futures gain is money coming in on top of the sale, the long hedger's futures gain is money knocked off the purchase.

The Role of Basis in the Net Result

Because the two legs offset, the hedger does not fully lock the flat price. What gets locked is the futures price plus whatever the basis turns out to be when the hedge is lifted (the ending basis).

• This is why hedging is often described as trading flat-price risk (large) for basis risk (small): the only thing left uncertain is where the basis lands.
• A favorable basis move improves the net result. For a short hedger (a seller), a stronger (higher, less negative) ending basis raises the net selling price. For a long hedger (a buyer), a weaker (lower, more negative) ending basis lowers the net buying price.
• A basis that moves the hedger's way can improve the outcome even when the flat price moved against them.

Exam Tip: Gotchas

• The net is anchored to the ENDING basis, not the starting basis. A question that hands you the opening basis plus the closing cash and futures prices is testing whether you use the basis at the lift. Compute cash minus futures at the close, then add it to the initial futures price.