by Dwayne Strocen

Created on: April 22, 2010   Last Updated: April 23, 2010

Hedging, understanding the benefits of risk management in an enterprise wide solution.  Risk management and hedging is a useful tool to reduce market place liability.  Here are some tips on its uses.

Second of a two part article
Before discussing the use of hedging to off-set risk, we need to understand the role and the purpose of hedging.  The history of modern futures trading began in Chicago in the early 1800's. Chicago is located at the base of the Great Lakes, close to the farmlands and cattle country of the U.S. Midwest making it a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. This led to the development of a market enabling grain merchants, processors, and agriculture companies to trade in contracts to insulate them from the risk of adverse price change and enable them to hedge.

The first commodity exchange was the creation of the Chicago Board of Trade, CBOT in 1848.  Since then, modern derivative products have grown to include more than the agricultural industry.  Products also include Stock Indices, Interest Rates, Currency, Precious Metals, Oil and Gas, Steel and a host of others.  The origins of the commodity and futures exchange was created to support hedging.  The role of speculators is beneficial as they add trading volume and important volatility to what would otherwise be a small and illiquid market place.

A bona-fide hedger is someone with an actual product to buy or sell.  The hedger establishes an off-setting position on the futures or commodity exchange, thereby instituting a set price for his product.  Someone buying a hedge is known as being "Long" or "Taking Delivery".  Someone selling a hedge is known as being "Short" or "Making Delivery".  These positions known as "Contracts" are legally binding and enforced by the exchange.  You can view a complete listing of the worlds different exchanges at world exchanges.

Entering your trades either for speculation or hedging is done through your broker or Commodity Trading Advisor.  Commodity and Futures exchanges are distinct from Stock Exchanges, although they operate using the same principals.  They are regulated by different agencies such as the Commodity Futures Trading Commission who are responsible for regulation of retail brokers in the USA as well as Commodity Trading Advisors who are Portfolio Managers.

Now

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