Hedger or Sp By Joe Lardy THE REAL DIFFERENCES AND WHY THE MARKET NEEDS BOTH What Do All Those Terms Mean? FUTURES MARKET: An auction market in which participants buy and sell commodity futures contracts for delivery on a specifi ed future date. FUTURE: A fi nancial contract obligating a buyer to purchase an asset at a predetermined future date and price. OPTION: A fi nancial derivative contract that off ers the buyer the right, but not the obligation, to buy (call) or sell (put) futures at an agreed-upon price (the strike price) during a certain period of time or on a specifi c date (exercise date). MARGIN: Collateral the holder of a future has to deposit to cover some or all of the credit risk. LONG THE MARKET: To buy a security. Most of the time someone long the market wants it to go higher. The exception is someone who is long with put options; he wants the market to go down. SPECULATING: The practice of taking on risk to make money. HEDGING: The practice of using futures or other fi nancial instruments to reduce risk of an exposure to a physical asset. HEDGE FUND: A limited partnership of investors that uses high-risk methods in hopes of realizing large gains. W hat does it mean to be a speculator? Are speculators hedge fund traders staring at a computer screen and inputting orders as fast as they can? And are farmers who trade corn futures considered speculators? Here’s the skinny on the real diff erences between speculators and hedgers. Speculators are concerned with price changes in the market. They make their buying and selling decisions based on where they believe a commodity will be trading at some point in the future, whether that’s one day away or a year away. Speculators also know for certain that the futures market is going to fl uctuate. They look to profi t from those market fl uctuations because they are pure risk-takers. Hedgers want to reduce or eliminate price risk when markets move. Hedgers are generally risk-averse and look to the futures market to help eliminate some of their risk. A hedger will always have an exposure to a particular commodity. For example, a corn farmer is inherently always long corn while a bread maker is always short the input of wheat. Think of futures as a type of insurance that gives producers and consumers the ability to lock in prices and take away the risk of a fluctuating market. Anyone who is not a hedger is a speculator. But if the markets go down, not only could his futures lose money, but his cash sales might be less than his production costs, so he loses there, too. A Texas hedger is someone who just reclassifi ed himself out of the hedger category and fi rmly into the speculator category. The relationship between the two groups operates as opposites. The chart shows the net position in the corn market of both groups. When the commercials (farmers) sell a lot, the non-commercials (speculators) are buyers. Get a Plan The best traders, whether hedgers or speculators, prepare their game plans before making any trading decisions. Producers need a detailed breakdown of their costs so they can establish profitable selling levels in their marketing plans. Speculators must have plans to preserve capital. A good speculative trader follows his game plan and will get out if he’s wrong — and get out when he’s right. In the classic trading movie, “Wall Street,” Gordon Gekko says, “Greed is good.” Unfortunately, greed too often leads to poor decisions and poor results in the bank account. Recently, several high-profi le commodity-based hedge funds shut down due to big losses and a shift in investor preferences. No matter what category you’re in, CHS Hedging is committed to helping you make the right decisions for the right reasons. Since 1986, CHS Hedging has been a futures commission merchant providing brokerage and risk-management services, as well as educational programs. CHS Hedging off ers a variety of choices, such as futures, options and OTC Compass contracts, to help customers manage risk and take advantage of market opportunities. Q Texas Hedge Too often, even the market’s best hedgers can be led astray, using a strategy called a “Texas hedge.” That is an investment that increases exposure to a particular risk. It would be like a corn farmer buying corn futures. If the corn futures market goes up, the farmer can sell his physical product for more money, as well as sell his futures position for a gain. The farmer wins on both the physical and the fi nancial. 14 NOVEMBER/DECEMBER 2015 This information is provided by a research analyst of CHS Hedging, LLC, and should not be construed as a recommendation to buy or sell any commodity contract. CHSINC.COM
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Hedger or Speculator?
Joe Lardy
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