l sugar
would be increased by 2.00. You would then buy futures at 8.00 to cover
your short sale at 6.00, netting a loss thereby of 2.00. This loss
would be added to your original cost of 6.00, making your actual sugar
cost 8.00, which is the market price at the time. Had you omitted the
hedge, your sugar would have cost you only 6.00, but, in this example
we are assuming that you would sell only when you were willing to
figure your sugar cost at the market price. This you have accomplished
by foregoing the speculative profit you _might_ have made in favor of
your normal jobbing profit.
If the market should remain relatively stable you would buy to cover
your hedge at approximately the same price as you sold for, your gain
or loss being practically nothing. In other words, you would obtain
sugar at the market price, which is the purpose in this kind of a
hedge.
HEDGING _to protect a gain on a favorable purchase of actual sugar_.
All sugar buyers have had the experience of buying actual sugar, only
to see it advance or decline before they have disposed of it. How to
protect the gain, or minimize the loss, is described in the two hedging
positions which we now discuss.
Suppose you have bought sugar, have _not_ hedged against it, and have
seen it advance. Finally you have said, "I think sugar is about as high
as it is going. I am going to sell against that to protect that
profit."
On the other hand, the reverse might be the case. You might find the
market going down, and say, "The market is going lower. I want to hedge
against that, and limit my loss to a definite amount."
CHART 2
----------------------------------------------------------------------------
HEDGING
to protect a gain on a favorable purchase of actual sugar
--------------+-----------------------------------------+----------+--------
Initial | |
Transactions | Subsequent Transactions | Result
--------------+--------+----------+---------+-----------+----------+--------
| Hedge |Condition |Price you| Result of | Figure | In
| |of market | pay for | hedge and | actual | each
| | when you | futures | covering | sugar | case
| | "cover" | to cover| operation | cost | the
| |your hedge| hedge | | this way | same
--------------+--------+----
|