What is a Long Hedge?

What is a Long Hedge?

Let me explain what a long hedge is—it's a futures position you take to lock in a future price for a commodity or raw material. This approach protects you against price increases by securing a set price ahead of time.

As cocoa beans more than doubled in price from 2024 to 2025, imagine you're a chocolate manufacturer needing more cocoa soon. You could use a long hedge to lock in those future prices.

Essentially, a long hedge means entering a futures contract to guard against price hikes on materials you'll buy later. For instance, an airline might hedge against rising jet fuel, or a jewelry maker against gold price increases.

By going long on futures, you cap what you'll pay months ahead, helping predict costs and safeguard profit margins in volatile markets.

Key Points on Long Hedges

Long hedges shield buyers from rising prices by fixing costs via futures. Their success hinges on the hedge ratio, which is the portion of your purchase you hedge. Think of them as insurance: they cost something, but they buffer against bad price moves. They don't wipe out all risks, but they cut down on volatility significantly.

Understanding Long Hedges

If you know you'll need raw materials later, price jumps can be a big concern. A long hedge addresses this by having you buy futures that gain value if prices rise, offsetting your higher spot market costs.

Futures are regulated instruments traded on exchanges like the CME. Entering one means you're committed to buy or sell at a set price on a future date.

These have become key in finance, from food firms hedging crops to investors betting on prices. It's like insuring your buys—if prices climb, the contract covers the extra; if they drop, you lose on the hedge but save on the actual purchase.

Manufacturers needing copper, aluminum, or wheat use this often, as do airlines for fuel.

Fast Fact

For you as a consumer, long hedges matter because without them, producers couldn't keep product prices steady.

Example of a Long Hedge

Suppose you're a cookie manufacturer needing 10,000 pounds of sugar in six months. Sugar's at $0.50 per pound now, but it's rising, and you're concerned.

You buy futures for 10,000 pounds at $0.55 per pound for July delivery. Here's what happens in two cases.

Scenario 1: Prices Rise

July price hits $0.65 per pound. Your physical buy costs an extra $1,500 ($0.15 more per pound). But your futures profit $1,000 ($0.10 gain per pound). Net, you only pay $500 more, not $1,500.

Scenario 2: Prices Fall

July price drops to $0.45 per pound. You save $500 on the buy ($0.05 less per pound). But you lose $1,000 on futures ($0.10 loss per pound). Overall, costs are higher, but you're safe from worse rises.

Hedge Ratios

The hedge ratio shows your protection level against price shifts. If you need 10,000 pounds of sugar, hedging 80% means an 80% ratio.

A 100% ratio covers everything; 50% covers half. You rarely go full because over-hedging is like excess insurance—you want flexibility.

Tip

There's no perfect hedge ratio—it's about balancing protection and flexibility for your needs.

How Companies Set Long Hedge Prices

You don't pick prices randomly; use the cost of carry model, starting with the spot price and adding storage, insurance, financing, and any income from holding.

For gold at $2,600 per ounce with 5% interest, a one-year future might be $2,750. It gets trickier with seasonal or high-storage items like crops or oil.

Different markets have their own pricing factors—I'll skip a table here, but know it's tailored per commodity.

Hedging With Marketing vs. Futures Contracts

Producers hedge via marketing contracts or futures. Marketing ones are direct deals between you and a buyer, like a farmer agreeing to sell milk at $3.50 per gallon monthly.

They're custom, acting like preorders without exchange trading.

Fast Fact

Small producers like marketing contracts to avoid margin calls and complexity.

Futures Contracts

Futures are standardized on exchanges, like 5,000-bushel corn contracts. They're more about price insurance than delivery.

What Are Short Hedges?

A short hedge means shorting to lock in sales prices against drops. An oil producer might hedge future output to secure today's prices, common in ag and resources.

What's the Difference Between Long and Short Hedges?

Both manage price risk: long for buyers fearing rises, short for sellers fearing falls.

Which Companies Typically Use Long Hedges?

Manufacturers, food processors, airlines—anyone buying commodities regularly to avoid price uncertainty.

Which Companies Engage in Short Hedges?

Producers selling later, like steel makers with delayed orders or energy firms hedging production.

The Bottom Line

Long hedges are vital for buyers of commodities to lock in prices and fend off rises, stabilizing your operations. But if prices fall, you might pay more than spot. Align them with your needs and market views for best results.