------+---------+-----------+----------+---------
You buy actual| | | | |Price paid|
sugar at 6.00,| | | | |for actual|
but before you| |It has | | |sugar less|Your
have received | |declined | | |hedging |sugar
it (or before | |to | |A profit |profit |cost
you sell it) | |6.00 | 6.00 |of 2.00 |6-2=4.00 |is
the price | | | | | |2.00
advances to | | | | | |under
8.00 | | | | |Price paid|the
| | | | |for actual|market
You now have |You sell|It has | | |sugar plus|
your sugar at |futures |advanced | | |hedging |
2.00 under the|at |to | |A loss |loss |
market |8.00 |10.00 | 10.00 |of 2.00 |6+2=8.00 |
| | | | | |
You feel that | |It stands | |No profit, | |
the market may| |at 8.00 | 8.00 |no loss | 6.00 |
recede and | | | | | |
eliminate | | | | | |
this gain, | | | | | |
so-- | | | | | |
--------------+--------+----------+---------+-----------+----------+--------
In both of these cases, the operation is relative. If a man has a
profit, let us say 2c a pound, and he hedges, he maintains his profit
of 2c a pound as compared with the market at the time of delivery, or
at the time when he expects to sell this sugar, regardless of whether
the market is higher or lower.
In the same way, conversely, if he has a loss on his sugar of 2c a
pound, by hedging he can limit that loss to 2c a pound, even though the
market goes still lower. In other words, his sugar cost at the time of
delivery, or at the time when he expects to sell the sugar, will be
about 2c above the market price, whether the market is higher or lower.
We shall assume that you have bought from a refiner through your broker
a supply of actual sugar at 6.00. While your sugar is in transit or
before it has been shipped by refiners, the market
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