Speculation vs. Hedging Section 4. Speculation What is speculation? Taking a position in the market...
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Transcript of Speculation vs. Hedging Section 4. Speculation What is speculation? Taking a position in the market...
Speculation vs. Hedging
Section 4
Speculation
What is speculation?
Taking a position in the market in order to make money on the rise and fall of futures prices of certain commodities.
Speculation
Buy a contract at a low price, then turn around and sell the contract at a high price.
Buy low, sell high.
Speculation
Sell a contract at a high price, then turn around and buy the contract at a low price.
Sell high, buy low.
Speculator’s Role
Provides risk capital Provides volume and liquidity Keeps some markets in alignment through
arbitrage
Why Speculate?
Increase a small amount of money to a large amount of money
Supplement Income Stimulation of the game
Why have rules?
Less than 25% of all
speculators
are successful
Rules for Speculation
Use money you can afford to lose Know yourself Don’t overcommit Don’t trade too many commodities When you are not sure - stand aside Block out other opinions Trade the most active contracts
Rules for Speculation
Never put your entire position on at one price
Never add to a losing position Cut your losses short Let your profits run Learn to like losses Use stop orders Get out before contract maturity
Rules for Speculation
Learn to sell short Don’t reverse your position Avoid picking tops and bottoms Take a trading break Buy bullish news, sell the fact Act Promptly Don’t form new opinions during
trading hours
Manner in Which Speculators Trade
Position Trader Day Trader Scalper Spread
Spreads
Simultaneously taking a long position in one futures contract
against a short position in another futures contract
Types of Spreads
Interdelivery spread – futures contacts for the same commodity traded on the same exchange are spread between two different delivery months
Example: July Wheat and
December Wheat
Types of Spreads Inter-market Spread
Example: Chicago Wheat and Kansas City Wheat
Inter-commodity Spread Example: Corn and Oats
Commodity-Product Spread Example: Soybeans and Soybean
Oil or Meal
Hedging
What is hedging?
Taking an equal and opposite position in the futures market to that in the cash market in order to insulate one’s business against price level speculation.
Why hedge?
Too much price risk Highly leveraged Some banks require it as part of a
loan agreement
Causes of Price Risk
Time difference between production and marketing
Uncertain nature of farm production
National or international policies
The Producer’s Hedge
The Producer’s Hedge
Date Cash .
Mar. 1: Est. Price $2.60
Nov. 1: Harvest & sell @ $2.40
Futures .
Sell: Dec. futures @ $3.00
Buy: Dec. futures @ $2.80
The Producer’s Hedge
Date Cash .
3/1: $2.60
11/1: Sell $2.40
-$0.20
Futures .
Sell: $3.00
Buy: $2.80
+$.020
The Producer’s Hedge
The producer sold crop at $2.40 in the market at harvest.
Bought back the futures contract for $2.80.
The Producer’s Hedge
The producer gained $0.20 in the futures market to add to earnings in the cash market.
The Producer’s Hedge
Nov. 1 cash price = $2.40
+ futures gain = $0.20
Total return = $2.60
Note: Estimated return = $2.60
The Processor’s Hedge
The Processor’s Hedge
Date Cash .
Mar. 1: Lock in $5.40
Nov. 1: Buy @ $7.00
Futures .
Buy: Mar. @ $5.70
Sell: Mar. @ $7.30
The Processor’s Hedge
Date Cash .
3/1: $5.40
11/1: Buy $7.00
Futures .
Buy: $5.70
Sell: $7.30
+$1.60
The Processor’s Hedge
Processor bought grain for $7 in cash market. Sold futures contract for $7.30. Gained $1.60 in the futures market to help cover
cost of grain purchased.
The Processor’s Hedge
Nov. 1 cash price = $7.00
+ futures gain = -$1.60
Net cost = $5.40
Note: Estimated price = $5.40