HEDGING to protect a normal jobbing profit by eliminating the probability of a speculative loss or gain.
This operation is particularly useful to jobbers with whom conditions are such that they desire to be assured that their cost will be at about the market price at the time they dispose of their sugar, regardless of whether the market be higher or lower.
Although there are times when any jobber, no matter where located, will find this a useful transaction, it is obvious that many buyers will not wish to use the market in this way unless they feel it will decline. But it is particularly of advantage to a jobber located in markets necessitating a delay of from one day to several weeks in transit.
For instance, on a certain day in April, two jobbers bought their usual quantity of sugar. One was located in Syracuse, the other in New York. Two days following the purchase, the market broke half a cent per pound. In view of the fact that his sugars were still in transit when the market declined, the Syracuse buyer was obliged to sustain this entire loss, in order to meet competition. On the other hand, because he received and distributed the sugar before the market broke, the New York jobber was able not only to avoid a loss, but make his regular profit.
CHART 1
| HEDGING to protect a normal jobbing profit by eliminating the probability of a speculative loss or gain | ||||||
|---|---|---|---|---|---|---|
| Initial Transactions | Subsequent Transactions | Result | ||||
| Liquidating the hedge (covering) | Condition of market when you "cover" your hedge | Price you would pay in covering | Result of hedge and covering operation | Figure your sugar cost this way | In each case the same | |
| You buy actual sugar at 6.00 | When you sell your sugar (or when it is delivered) you buy the same amount of futures at the market price, whether higher or lower. | It has declined to 4.00 | 4.00 | Profit 2.00 | Actual cost less profit 6-2=4 | You get your sugar at the market price at the time when you sell it (or when your delivery is made.) |
| It has advanced to 8.00 | 8.00 | Loss 2.00 | Actual cost plus loss 6+2=8 | |||
| At the same time you hedge by selling the same amount of futures at 6.00 | It stands at 6.00 | 6.00 | No profit, no loss | Actual cost | ||
Naturally the greater the amount of sugar any one concern may have in transit the greater the need for protection. We call this kind of transaction particularly to the attention of buyers having branch houses who find themselves obliged to make relatively large purchases to supply their trade in the face of a market in which they have no confidence.
These disadvantages at which out-of-town buyers are sometimes placed might be overcome by using the Exchange. On the other hand, when refiners are badly behind on deliveries, even buyers located at the source of supply will find themselves facing a similar problem the solution of which may be found in a use of the Exchange.
It is therefore evident that the selling of futures may be a transaction the sole purpose of which is to eliminate speculation from a jobber's business.
Regardless of how careful a buyer may be, there is an element of speculation in each purchase of actual sugar.