Introduction to Hedging Agricultural Commodities with Futures

Abstract

Producers of agricultural commodities regularly face price and production risk. Furthermore, increased global free trade and changes in domestic agricultural policy have increased these risks. As the variability of price and production increases, producers are realizing the importance of risk management as a component of their management strategies. One means of reducing these risks is through the use of the commodity futures exchange markets. Like the use of car insurance to hedge the potential costs of a car accident, agricultural producers can use the commodity futures markets to hedge the potential costs of commodity price volatility. However, as with car insurance, where the gains from an insurance claim might not exceed the cost of the cumulative sum of premiums, the gains from hedging might not cover the costs of hedging. The primary objective of hedging is not to make money but rather to minimize price risk, and this includes using hedging to minimize losses. This guide provides an overview to agricultural hedging to aid in evaluating hedging opportunities.