Market News & Headlines >> Brock Consultant Katie Hancock's Blog: A Hedge Loss Can Be a Winner
Insights from Brock Associates Consultant Katie Hancock
Hedgers that use futures contracts to manage risk tend to look back at success in terms of profit or loss in the hedge account. In reality, it’s not as simple as analyzing one positive or negative number. A hedging gain isn’t necessarily good and a hedging loss isn’t necessarily bad.
Let’s say farmer Frank uses his futures account to hedge corn. He shows a gain of $100,000 on his 400,000 bushels of production. He is pleased to add an additional 25 cents to his day-of-delivery elevator price of $3.75. His selling price totals $4 per bushel.
Neighbor Tom uses his futures account to hedge corn also, but his timing is different. He shows a loss of $100,000 on his 400,000 bushels of production. He is disappointed to discount 25 cents per bushel from his forward contracted elevator price of $4.50. His price totals $4.25 per bushel.
What’s the difference between the two results? Tom feels like a failure to have a hedging loss and Frank feels like a success having a hedging gain. In reality, Tom was more successful.
Had neither hedged at all, they could have spot priced their corn at $3.75. They were each successful in managing downside risk, but Tom has to explain his loss while Ted is celebrated for his gain.
Look at the picture as a whole. The take home point is that Frank’s hedging gain wasn’t as profitable as Tom’s hedging loss. Don’t discount the efforts of yourself or others in hedging until all details are considered.
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