Hedging deals - reducing trading risks

In this article, we will talk about what hedging is and whether it is used in trading operations on the FOREX market. First of all, we will determine what this term means. Hedging is the insurance of financial risks for an open transaction by conducting transactions on other instruments.

For example, a seller company enters into a contract to deliver a consignment of goods to a counterparty in three months. As of the date of conclusion of the contract, the market price of the batch is 1,000,000 USD. In order to guarantee the receipt of this particular value on the delivery date, in the event of a price drop, the seller can use several different methods. The first way is a non-deliverable futures contract. The seller on the date of signing the supply contract sells futures for such goods in the amount of 1,000,000 USD. In the event of an increase in market value after three months, the seller receives his price and a loss on the cost of servicing the futures (this will be the hedging price). In the event of a drop in the price of the goods, the seller still receives the contract price due to the futures, which in this case did not allow to incur losses minus the cost of its service.

The second way is to buy an option on the right to sell the goods indicated in the contract for 1 000 000 USD in three months. In this case, the hedge price will be the amount of the premium for the option.

As a rule, participants in the commodity and exchange markets resort to hedging. On FOREX, where real delivery does not occur, this mechanism is not applied in this form. Both options and futures are separate and self-sufficient instruments that are traded on commodity and stock exchanges.