Therefore, it is obvious that although the exchange market should be on a parity with the actual market, the unequal fluctuations of the two markets will be constantly throwing them out of parity or "out of line."
There are times when the market will be so out of line that the buying of futures should result profitably. At other times, with conditions reversed, selling of futures seems obviously advisable. We do not claim that jobbers can protect sugar purchases with absolute and exact precision. On the basis of long exchange experience, we do believe, however, that by a discreet use of the Exchange, and by using the market when quotations are favorably out of line, jobbers can do so to their decided advantage.
Selling of Futures—Hedging
As the word itself indicates, a "hedge" on the Exchange is a protection.
You hedge by buying or owning actual sugar, and "selling short" in the same amount. You sell sugar futures although you do not own any. You actually contract to deliver an amount of sugar during a specified future month at a specified price.
Eventually, you must either buy and deliver actual sugar to carry out this contract, or you must buy another contract for futures to cancel your short sale. This is known as a "covering" operation, and the cancelling of one by the other takes place automatically through the channels of the Exchange.
From the jobber's point of view, the operation of hedging has three outstanding purposes. He may hedge:
1. To eliminate the probability of speculative profit or loss, due to market fluctuations.
2. To protect a profit on a favorable purchase of actual sugar.
3. To establish and limit a loss on an unfavorable purchase of actual sugar.