Hedging as Practiced
By Cotton Manufacturers
The manufacturer’s hedging is necessarily somewhat different in practice, though the same in principle. If he accepts orders for cloth requiring more cotton than is being held in his warehouse, he may buy futures contracts to the amount of the additional cotton he will need. Then in the event that his actual purchase of cotton may be at a figure which would tend to reduce or eliminate his profits on the sale of the cloth, already fixed by contract, he may sell his futures contract at a corresponding profit, thereby preventing loss. Should the price of cotton fall in the interim, his profit on the sale of the cloth will be larger, but the settlement of his futures contract will be expensive to the same extent. Thus he sacrifices the chance of a greater possible profit in order to be insured against loss.
Compress bales bound for New Orleans
It is probably more common for the cotton merchant to hedge than for the manufacturer to adopt that proceeding. The manufacturer, as a rule, has been accustomed to buy his cotton during the buying season, that is, in October, November, December, and January, and he makes his arrangements with his selling agents on the basis of the price paid, trusting to his own judgment, and the 25 comparatively small fluctuations in the price of cloth in normal times, to protect him against loss. It is usually believed that the Southern mills, being newer, and frequently of a different financial standing, have found it more desirable to have recourse to this form of insurance than their older competitors in the North. Then, too, the rapid development of the cotton warehousing system has made it less necessary for the manufacturers to tie their money up in great quantities of cotton, as they can buy when the market appears favorable.
Protection for Mills
Running for Stock
A very important point, however, and one which all manufacturers would do well to consider carefully is the protection which a "futures" market gives to a manufacturer making plain goods for stock, particularly on a falling raw material market, which, of course, would also mean a falling goods market. To stop the mill because values were falling would be impossible without utter disorganization, and its attendant heavy loss, while to keep on manufacturing stock goods with a certainty that they would be worth less each succeeding month is a disheartening prospect for the mill.
If, however, the manufacturer sells "futures" for the succeeding months to the extent of the cotton which he would require each month to manufacture the goods, he can run his machinery as usual and have a perfectly free mind, as he has safeguarded himself against any loss due to a falling value of the raw material. Suppose, for instance, the cotton market fell off, say one cent a pound each month, with a corresponding fall in the value of the woven goods. In such an event, the manufacturer could, as each month arrived, buy a contract for an amount corresponding to what he had sold, and at a proportionately less price, thus making a profit on the "futures" which he had sold to an extent which would correspond, approximately, to the smaller value which his manufactured goods would then have in the market. Thus the profit on the one side would take care of the loss on the other. If the market rose instead of falling, he would make a loss in replacing his futures contract, but his goods would then command a higher value, and again no loss would be experienced.
This method of hedging is the regular and standard practice of the English cotton mills, and, of course, of many of our domestic mills, but there are some manufacturers who, through their unfamiliarity with the operations of the futures market, are quite unaware of the protection which they thus have at hand.