How can you explain commodities , futures and the link to farming to a child?
Sunday, March 29th, 2009 at
12:00 am
Raisinable asked:
I’ve tried a lot of websites and books but none of them break it down fully for someone just getting familiar with this. I basically understand the idea of hedging, but I get a bit lost when people talk about spreads and basis and most of all, I don’t understand the link between physical commodities and all these bits of paper that are apparently traded on futures exchanges.
I’ve tried a lot of websites and books but none of them break it down fully for someone just getting familiar with this. I basically understand the idea of hedging, but I get a bit lost when people talk about spreads and basis and most of all, I don’t understand the link between physical commodities and all these bits of paper that are apparently traded on futures exchanges.
Tagged with: Futures Exchanges • Lost • Lot
Filed under: Commodity Trading
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If a corn farmer looked in the paper and seen corn trading at 6$ a bushel and said to himself if only it was november and I had my corn harvested I could sell it and make a profit and be happy, but every year when I sell my corn the price is so low I loose money. Futures give the opportunity to the farmer to sell in Febuary and make a profit. He then would be hedged against the spot price of corn. So when November comes and the spot is 3$ a bushel his 5000 bushel harvest would be down by 15,000$ dam!! but then he would he would buy back his futures contracts that he was allready paid for 15,000$ less meaning he made a profit of 15000(30,000 he originally received-15,000 to close out) The point here to understand as a true hedger he can never loose on the decrease in the price of the commodity whats the catch, he can never gain on an increase in the price. If the price of corn was 9$ a bushel in November he would be up 15,000$ on the spot price but to close out his futures hedge he would have to buy back his contracts for 15,000 more than he originally received. So whats the moral of this story he darn well better be happy with 6$ a bushel.