Futures Hedging Explanation (Buyer / Importer - Long Hedge)

Bank of Baroda — Major Initiatives (2025)

Hedging Using Futures – Buyer / Importer of Wheat (Long Hedge)

A buyer or importer of wheat is naturally short in the commodity because he needs to purchase wheat in the future. His concern is that the price of wheat may rise, making procurement expensive. To protect against this risk, he enters into a long futures contract.

Given:

• Current spot price (S₀) = ₹100
• Futures price fixed today (F) = ₹120
• Maturity = 6 months
• Position taken today = Long futures
• Quantity = 1 unit (for simplicity)

Case (i): Spot Price Falls

After 6 months, suppose the spot price (S_t) falls to ₹90.

Market	Result
Spot Market	Buys wheat at ₹90 → Gain of ₹10
Futures Market	Buys at ₹120, sells at ₹90 → Loss of ₹30
Effective Cost	₹90 + ₹30 = ₹120

Explanation: The benefit of a lower spot price is neutralized by the loss in futures.

Case (ii): Spot Price Rises

After 6 months, suppose the spot price (S_t) rises to ₹180.

Market	Result
Spot Market	Buys wheat at ₹180 → Extra cost of ₹80
Futures Market	Buys at ₹120, sells at ₹180 → Profit of ₹60
Effective Cost	₹180 − ₹60 = ₹120

Explanation: The higher spot price is offset by gains in the futures market.

Final Outcome (Core Learning)

Regardless of whether the price of wheat falls or rises, the buyer finally pays:

Effective purchase price = ₹120

This strategy is known as a Long Hedge.

Conceptual Clarity (Mirror Image)

Aspect	Producer	Buyer / Importer
Natural Position	Long asset	Short asset
Price Fear	Price fall	Price rise
Futures Position	Short futures	Long futures
Hedge Type	Short hedge	Long hedge
Final Result	Fixed selling price	Fixed buying price

Key Hedging Rules (Must Remember)

• Long exposure → Short hedge
• Short exposure → Long hedge
• Futures convert an uncertain future spot price into a certain price today

One-Line Intuition:
Producer: “I fear prices will fall → I sell futures.”
Buyer: “I fear prices will rise → I buy futures.”