By admin       2019-03-26

Hedging plays an important role as it reduces and controls risk arising from the market. The hedging process involves taking equal and opposite positions in two different markets—physical and futures market, and reduces risk associated with price change.By hedging, participants such as traders, stockists, exporters, companies, buyers, etc., can buy their requirements of the year in a futures contract by paying a margin of only 5% and lock prices for the entire year.Meanwhile, sellers can sell their estimated produce in advance at futures market and lock their prices. In case the prices fall, they can earn profit from the futures market.For instance, Prakash Kumar, a cotton ginner, had a huge stock of cotton for sale, however, he was sceptical about the gyrating prices in the market. In a bid to protect himself from losses, he hedged and locked-in the price for his cotton stock in October 2017. Let’s assume the spot price of cotton of 29mm in October 2017 was Rs 18,500 per bale and price in December 2017 for futures was Rs 18,700 per bale.He sold one lot of cotton in October futures contract in October at Rs 18,700 for a delivery in December. He paid the 5% margin of the contract value for entering a position in the futures market.The prices fell in December and the ginner sold his entire stock in the physical market for Rs 18,000 a bale. As he had already participated in the futures contract, despite facing a loss of Rs 500 per bale in cash, he gained Rs 600 per bale in futures.Likewise, hedging can save cotton sellers from going into losses. Thereby, hedging enables sellers to lock-in prices and immune themselves from fluctuating prices on the Exchange.

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