Part 4

If the market has advanced to 10.00, when it becomes necessary for you to cover your hedge (at the time of selling your sugar or when it is delivered) your hedging operations considered alone would net you a loss of 2.00. You would buy in futures at 10.00, which you sold at 8.00. Your original sugar cost was 6.00, your loss on your hedge was 2.00, so that you would figure your actual sugar cost at 8.00. But the market at that time was 10.00, so that you have accomplished your purpose of getting your sugar 2.00 under the market at the time of selling it (or at the time of delivery). In other words, you would make the same profit as though you had re-sold your sugar to second-hands originally, instead of hedging, but had you followed this course, you might not have had sugar in stock for your regular trade.

On the other hand, when it becomes necessary for you to cover your hedge, if the market has remained steady and is again at 8.00, the two futures transactions cancel themselves without profit or loss. Your original cost of 6.00, therefore, stands as your actual sugar cost at the time of selling (or at the time of delivery). This is 2.00 under the market and you have accomplished your purpose.

HEDGING to establish and limit a loss on an unfavorable purchase.

This operation is identical in its working with the previous example, except that you have a different end in view.

CHART 3

-------------------------------------------------------------------------- HEDGING to establish and limit a loss on an unfavorable purchase ------------+--------+---------------+-------+----------+----------+------- Initial | | Transactions| Subsequent Transactions | Result ------------+--------+---------------+-------+----------+----------+------- | Hedge | Condition of | Price | Result | Figure | In | | market when | you | of | actual | each | | you "cover" | pay | hedge | sugar | case | | your hedge | for | and | cost | the | | |futures| covering | this | same | | | to | operation| way | | | | cover | | | | | | hedge | | | ------------+--------+---------------+-------+----------+----------+------- You buy | | | | |Price paid| actual sugar| | | | |for actual| at 6.00 but | | | | |sugar less| before you | | | | |hedging | have | |It has declined| | A profit |profit | received it | |to 4.00 | 4.00 | of 1.00 |6-1=5.00 | (or before | | | | | | you sell it)| | | | | | the price | | | | | | declines to | | | | | | 5.00 | | | | | | | | | | | | You now have| | | | |Price paid|Your your sugar | | | | |for actual|sugar at 1.00 | | | | |sugar plus|cost is above the |You sell| | | |hedging |1.00 market |futures |It has advanced| |A loss of |loss |above |at 5.00 |to 6.00 | 6.00 |1.00 |6+1=7.00 |the | | | | | |market You feel | |It stands at | |No profit,| | that the | |5.00 | 5.00 |no loss | 6.00 | market may | | | | | | decline | | | | | | still | | | | | | further and | | | | | | increase | | | | | | this loss, | | | | | | so-- | | | | | | ------------+--------+---------------+-------+----------+----------+-------

Let us say that you purchase actual sugar at 6.00. If the market declines to 5.00 after your original purchase at 6.00, you have a loss of 1.00, in the value of your sugar. Facing the possibility of a further decline and desiring to limit this loss to 1.00, you hedge by selling futures. In this case you should limit your loss to 1.00 just as effectively as in the previous example you preserved your gain of 2.00, and by the same course of procedure. (See Chart 3.)

By the time it is necessary for you to cover your hedge by buying an equivalent amount of futures, the market may have declined still further, say to 4.00. You sold at 5.00, you bought at 4.00, profit on that operation, 1.00. Subtract this profit from your original cost (6.00) and figure your sugar cost at 5.00. In other words, although the market went still lower, you succeeded in limiting your loss to 1.00, as compared with the market price at the time of the delivery of your sugar (or at the time you sell it). Had you omitted the hedge, your actual sugar cost would have been 6.00, which was 2.00 above the market.

After your original purchase at 6.00, and market decline to 5.00 (at which point you hedged), the market might advance again to 6.00, or remain steady at 5.00, but the operation is no different from that previously described, and you in each case attain the same result.

Buying of Sugar Futures

Refiners do not make a practice of taking orders more than thirty days in advance of actual delivery--but there are obviously times when it is advisable to cover one's requirements for a longer period. A jobber may do this on the Exchange where he will always find a seller at some price for the quantity he desires.

This privilege is particularly valuable to:

1. Jobbers who believe that the market price of Sugar is going higher and who desire to cover their future requirements beyond the delay period which refiners will extend.

2. Jobbers, who desire to sell to manufacturing customers for future delivery at a fixed price so that these manufacturing customers may determine their selling price, may do so by the use of the Exchange.

1. Buying of sugar futures--Based upon the expectation of higher prices

No doubt many jobbers will recall occasions when anticipating their requirements seemed obviously advisable, perhaps almost imperative. Such a jobber would be one who believed in the market. His action would be based on his opinion of the market. He might note in January, let us say, that the price of May or July futures is favorable. He would like to get his May or July sugar at about that figure. You yourself probably can recollect many times in the past, when the general market was in such a strong position fundamentally that anticipating your requirements seemed advisable. You decided to buy a considerable quantity only to find that refiners would not sell you to the extent that you wished to purchase. When covering your future requirements on the Exchange, you can buy any quantity desired.

Consider also on how many occasions when you wanted and needed a definite future month of shipment, you have been told that "as soon as possible" was the only acceptable basis.

Or have you had the experience of placing an order and waiting twenty-four or thirty-six hours without knowing if the refiner would accept your order? Meanwhile the market might have advanced, and, if your order had been declined, you would have had to pay an even higher price for your sugar. The facilities of the exchange offer opportunities for protecting requirements quickly and without the uncertainty and delay sometimes encountered from refiners.

A jobber must anticipate the market in order to take full advantage of it, and in this connection it should be borne in mind that the Sugar Exchange, as in the case of practically all exchanges, usually anticipates either favorable or unfavorable developments in the market for the actual commodity. Consequently, prompt action is necessary when either a higher or lower market is expected, as the Exchange market will usually be the first to reflect changing conditions.

Suppose you feel that the price of sugar is low and probably going higher. You try to anticipate your requirements for some time to come, but find that refiners will not sell for more than thirty days.

You can go on the Exchange and buy futures in the quantity and month desired. Assume then, that you pay 6.00 for your futures. Now, whatever happens in the sugar market, you know you can get the quantity of sugar desired at about 6.00 (see Chart 4).

The market will advance, decline or hold steady.

Say the market advances. When it seems advisable to close out your Exchange contract and buy actual sugar, the price may have gone up to 8.00. You will then sell your futures at about 8.00, go into the market and buy actual sugar at the same price, assuming, of course, that the actual market has advanced in relative proportion--which is likely. Although actual sugar has cost you 2.00 more than you had figured, you have made 2.00 on your futures. Profit and loss cancel each other. Your sugar cost is 6.00.

On the other hand, suppose the market declines after you have bought futures at 6.00, and goes down to 4.00, when it seems advisable to close out your Exchange contract. You sell your futures at 4.00, a loss of 2.00. But you will also buy your actual sugar at 4.00, which is 2.00 lower than you had planned. Your actual sugar cost was therefore 6.00, which is the price you had figured was favorable.

If the price still is at 6.00 when you desire to liquidate, you would sell your futures and buy your actual sugar at about the same price. Thus you have neither gained nor lost, but you have been sure of getting sugar at 6.00, which is the price you felt was low.

The time to buy actual sugar is generally when the market becomes strong and an advance in the price of the actual commodity seems imminent; but the time to buy sugar futures is before the strength develops. The future market invariably discounts declines and anticipates advances.

2. Buying of Sugar Futures to protect profits on advance sales to customers

While it may not be an established custom, we know numerous instances where jobbers have sold sugars in small quantities for future delivery. The examples to which we refer are small manufacturers buying sugar locally, who, when the market appears in a strong condition desire to be assured of their regular supply of sugar at a specified price. Under such conditions we have known jobbers to sell them sugar for delivery over several months. If at any time you are placed in a similar position, and desire to take care of your customers in this manner, without incurring too great a risk, the Exchange offers exceptional opportunities for protection, as, of course, you would be able to buy sugar for delivery in any month you desire, even as far in advance as one year.