Emerging Earning Mechanism and Opportunities in Investment

Hedging

Hedging is a mechanism by which the participants in the physical markets can cover their price risk. Theoretically the relationship the future and cash price is determined by cost carry. The two prices therefore moves tandem. This enables participants in the physical markets to cover their price risk by taking opposite position in the futures market. Hedging can be done in various ways.

Types of Hedging

Mainly there are two types of hedging;

Long hedging

A Hedge that involves al long or buy position in future contract is known as long hedging. It is appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a price today to escape from risk arising due to an increase in price at a future date.

Short Hedging

A hedge that involves a short or sells position in the futures contracts is called short hedging. It is appropriate when the hedger already owns an asset and expects to sell it in future and wants to escape from the risk of falling prices of commodities in the future date.

Metal Hedging

There are two basic cases in hedging:

In case of stock but no order:

Let us assume a trader has a stock of 500 kg Silver@ Rs. 41,000/kg. If the price decrease by Rs. 500/kg then the total loss will be Rs. 2, 50,000. Now need to think to recover the loss. This loss can be recovered by taking a short or sell position on the same platform or different platform with the small additional initial margin required with a trading that amount of contract. Whatever loss is incurred by decrease in price of the physical stock is recovered through the profit shown by sell in the platform. As soon the physical stock is sold the sell position in the software is settled by taking a counter buy and completing the transaction.

In case there is an order and the stock is not there:

 Let us assume that the dealer receives or expects and order of 20 MT of copper in 2 months at a later date and the current price is 600 NPR/kg. if the price of copper increased by 100 rupees/kg in future date then the dealer has to pay an excess of NPR 20,00,000 , when the price has increased. In order to avoid this he can buy 20 lots of copper futures and cover the excess price that he has to pay at a late date.