10th Nov 2009 by JonB
Hedging refers to any activity that helps insure you against potential losses. Many companies use futures, options, stocks etc to hedge various aspects of their business. Here's one straight forward example:
If you own a towing company, the cost of gasoline can have a huge impact on your bottom line. If you think the price of gasoline is going to jump, you may wish to lock in the price of gasoline for the next year. You could of course simply go out and buy a years worth of gasoline, but that would be costly and potentially cumbersome when it comes to storing it. If you bought gasoline futures at todays price, you would only have to pay a fraction now, there would be no worries about storage and you would have the price locked in for a year. The risk you take is that if the price of gasoline drops, you're stuck paying the old price.
This a very simple example. As you can imagine, companies sometime have whole departments dedicated to managing and acquiring these hedging positions using a variety of tools: options, futures, options ON futures etc etc. It is said t hat futures were developed simply because it was impossible to store large amounts of goods for long periods of time.
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