A successful hedging operation is often not as simple as we think. Here are some problems to be paid attention to in the hedging operation.
1 selection of futures contracts
The key to hedging lies in the degree of correlation between futures and spot prices. The higher the correlation between the two, the smaller the basis risk will be, so the better the hedging effect will be. Therefore, when you choose futures contracts, you should be as close as possible to the physical commodities. In other words, when you choose futures contracts, you should choose contracts with a smaller base.
2. Selection of expiration month of the futures contract
A hedger has two options when it is uncertain when to dispose of a spot commodity, or when the time to dispose of a spot commodity is not exactly the same as the month of maturity of the futures contract. The first is to select the futures contract of the recent month, then write off the position before the expiration of this contract, and then convert it into the futures knowledge contract of the next month, and so on; The second is to opt for contracts that are closer to the spot time but farther away from the expiration date than they might be, without having to go through too many conversions of futures contracts.
3. Entry time of hedging
The entry timing of hedging refers to the question of when to enter and buy futures and the number of times to buy and sell futures. If the goal of hedging is to maximize utility, he does not need to hold a futures contract at any point in time, but only needs to write it off when he thinks the market will move against him. This hedging method is commonly called selective hedging.
Unfortunately, there is no answer to the question of when markets will move in favor or against them. Therefore, if the hedge does not want to take any risk and only wants to lock in the spot market price at a fixed level, it should adopt a continuous hedging strategy.
A continuous hedging strategy is a strategy in which the hedger constantly adjusts the number of futures he or she holds in accordance with the increase or decrease of his or her position in the spot market in order to completely eliminate the price risk. However, such a strategy can be risky and costly.
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