Bank of Baroda — Major Initiatives (2025)
Hedging Using Futures – Wheat Producer (Short Hedge)
A wheat producer is naturally long in wheat because he will produce wheat in the future. He is worried that the price of wheat may fall by the time he sells his produce. To protect himself from this price risk, he enters into a short futures contract.
Given:
- Current spot price (S0) = ₹100
- Futures price fixed today (F) = ₹120
- Maturity = 6 months
- Position taken today = Short futures
Case (i): Spot Price Falls
After 6 months, suppose the spot price (St) falls to ₹90.
| Market | Result |
|---|---|
| Spot Market | Sells wheat at ₹90 → Loss of ₹10 |
| Futures Market | Sells at ₹120, buys at ₹90 → Profit of ₹30 |
| Total Realisation | ₹90 + ₹30 = ₹120 |
Case (ii): Spot Price Rises
After 6 months, suppose the spot price (St) rises to ₹180.
| Market | Result |
|---|---|
| Spot Market | Sells wheat at ₹180 → Gain of ₹80 |
| Futures Market | Sells at ₹120, buys at ₹180 → Loss of ₹60 |
| Total Realisation | ₹180 − ₹60 = ₹120 |
Final Outcome
In both cases, whether the price falls or rises, the producer finally realises:
Effective selling price = ₹120
Key Insight: Hedging does not aim to make extra profit.
It aims to eliminate price uncertainty by locking in a fixed price.
Important Concepts to Remember
- Producer is naturally long in the spot market
- To hedge, he takes a short futures position
- Loss in spot is offset by gain in futures and vice versa
- This is called a Short Hedge
- Hedging removes uncertainty but also gives up upside benefit