Bites of trading knowledge #1

What is Hedging? –

Hedging is the action taken through the use of a financial instrument to minimize the loss or risk of the loss of value of an asset due to adverse asset price movements.

Who are Hedgers? –

Hedgers are market participants such as commodity producers who want to lock in selling prices of commodities they produce, or food manufacturers who want to lock in buying prices of raw materials purchased.

Market participants also include financial institutions handling financial assets and use derivative products such as futures to manage the risk of a portfolio of financial assets.

What is the difference between Physically Delivered vs Cash Settled Futures Contracts? –

Physical delivery is a term in a futures contract which requires the actual underlying asset to be “physically delivered” upon the specified delivery date, rather than being cash-settled.

Cash settled futures on the other hand allows for the net cash amount to be paid or received on the settlement date of the futures contract.

Futures exchanges may offer both types of contracts to market participants who have different purposes for trading futures contracts.

Risks and opportunities for corporates and individual investors: HEDGING –

Hedging currency exposure with the Mini U.S. Dollar Index ® futures contract is a way to manage business currency risk by taking a directional position depending on business requirements for conversions to or from the U.S. Dollar.

For example, a hedger may have expected the U.S. Dollar to weaken from 93.50 on 31st March (based on an analysis involving the overall downward trend in the market having retraced to the Fibonacci retracement level 76.8%) and may have had plans to convert U.S. Dollars to Singapore Dollars over the coming months to make payments to suppliers in Singapore Dollars. The hedger could have opened a short position using the Mini U.S. Dollar Index ® futures contract at or around 93.50 to lock in the value of the U.S. Dollars that they planned to use in the future at the time of payment to the supplier.