Soybeans producers can hedge against falling soybeans price by taking up a position in the soybeans futures market.
Soybeans producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of soybeans that is only ready for sale sometime in the future.
To implement the short hedge, soybeans producers sell (short) enough soybeans futures contracts in the futures market to cover the quantity of soybeans to be produced.
A soybean farmer has just entered into a contract to sell 500,000 bushels of soybeans, to be delivered in 3 months' time. The sale price is agreed by both parties to be based on the market price of soybeans on the day of delivery. At the time of signing the agreement, spot price for soybeans is USD 9.6900/bu while the price of soybeans futures for delivery in 3 months' time is USD 9.7000/bu.
To lock in the selling price at USD 9.7000/bu, the soybean farmer can enter a short position in an appropriate number of CBOT Soybeans futures contracts. With each CBOT Soybeans futures contract covering 5,000 bushels of soybeans, the soybean farmer will be required to short 100 futures contracts.
The effect of putting in place the hedge should guarantee that the soybean farmer will be able to sell the 500,000 bushels of soybeans at USD 9.7000/bu for a total amount of USD 4,850,000. Let's see how this is achieved by looking at scenarios in which the price of soybeans makes a significant move either upwards or downwards by delivery date.
As per the sales contract, the soybean farmer will have to sell the soybeans at only USD 8.7210/bu, resulting in a net sales proceeds of USD 4,360,500.
By delivery date, the soybeans futures price will have converged with the soybeans spot price and will be equal to USD 8.7210/bu. As the short futures position was entered at USD 9.7000/bu, it will have gained USD 9.7000 - USD 8.7210 = USD 0.9790 per bushel. With 100 contracts covering a total of 500000 bushels, the total gain from the short futures position is USD 489,500
Together, the gain in the soybeans futures market and the amount realised from the sales contract will total USD 489,500 + USD 4,360,500 = USD 4,850,000. This amount is equivalent to selling 500,000 bushels of soybeans at USD 9.7000/bu.
With the increase in soybeans price to USD 10.66/bu, the soybeans producer will be able to sell the 500,000 bushels of soybeans for a higher net sales proceeds of USD 5,329,500.
However, as the short futures position was entered at a lower price of USD 9.7000/bu, it will have lost USD 10.66 - USD 9.7000 = USD 0.9590 per bushel. With 100 contracts covering a total of 500,000 bushels of soybeans, the total loss from the short futures position is USD 479,500.
In the end, the higher sales proceeds is offset by the loss in the soybeans futures market, resulting in a net proceeds of USD 5,329,500 - USD 479,500 = USD 4,850,000. Again, this is the same amount that would be received by selling 500,000 bushels of soybeans at USD 9.7000/bu.
As can be seen from the above examples, the downside of the short hedge is that the soybeans seller would have been better off without the hedge if the price of the commodity went up.
An alternative way of hedging against falling soybeans prices while still be able to benefit from a rise in soybeans price is to buy soybeans put options.
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