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Adam Pukalo, CIM

Investment & Commodity Futures Advisor

 

Proven Independent Investment Management

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  2. Client Education
  3. What is Hedging?

What is Hedging?

Hedging is a way to control the risks associated with volatility in grains, livestock and currencies etc.

The easiest way to think of hedging is an analogy using insurance.

Every year you pay a premium to buy house insurance to protect it from a negative event.

Similarly, you can use options and futures to do the same thing to protect from declining prices of your grains and livestock.

You might be thinking…how does this differ from crop/livestock insurance that already exists?

 

There are two main differences:

  1. Flexibility

    You can sell your protection at any time because it is traded on an exchange called the CME Group like how stocks are traded on the Toronto Stock Exchange.

    Coming back to our car insurance analogy, imagine you could sell your house insurance back in nine months because you believe it isn’t needed anymore and you can get a certain percentage of your premium back.

    Wouldn’t it be nice to have that flexibility?

    If you find your cash price of your grains or livestock increasing and you may not need your protection on anymore, you can sell it back at any time.

  2. Defined Risk

    The premium you pay for your house insurance is the maximum amount you’ll lose if nothing happens to your house.

    Same thing for when you buy option protection…

    When you buy option protection the maximum amount you can lose is the premium you pay.

    Many people have heard of the dreaded “margin call” from futures and buying options address this concern.

    You can now have the protection you want and have your total risk defined to just the premium you pay.

 

Why hedge using options and futures?

  • Flexibility over other insurance programs
  • Defined risk with no futures contract margin calls
  • Fix consistent and stable cash flow
  • Minimal capital requirements
  • No production commitment or delivery risk

CME Group’s Guide to Managing Price Risk with Grain Futures & Options – CLICK HERE

CME Group’s Guide to Options on Livestock Futures – CLICK HERE

Client Education

  • What is Hedging?
  • What is Speculating?
  • Terminology
  • Technicals & Trends Report
  • Featured Strategies

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PI Financial Corp. is licensed as a broker-dealer in all provinces and territories of Canada and is a member of the IIROC and the Canadian Investor Protection Fund. The contents of our Website are not intended, and should not be construed, as a solicitation of customers or business in any jurisdiction in which we are not registered as a dealer in securities.

The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. In considering whether to trade or the authorize someone else to trade for you, you should be aware of the following. If you purchase a commodity option you may sustain a total loss of the premium and of all transaction costs. If you purchase or sell a commodity futures contract or sell a commodity option or engage in off-exchange foreign currency trading you may sustain a total loss of the initial margin funds or security deposit and any additional fund that you deposit with your broker to establish or maintain your position. You may be called upon by your broker to deposit a substantial amount of additional margin funds, on short notice, in order to maintain your position. If you do not provide the requested funds within the prescribe time, your position may be liquidated at a loss, and you will be liable for any resulting deficit in your account. Under certain market conditions, you may find it difficult to impossible to liquidate a position. This is intended for distribution in those jurisdictions where PI Financial Corp. is registered as an advisor or a dealer in securities and/or futures and options. Any distribution or dissemination of this in any other jurisdiction is strictly prohibited. Past performance is not necessarily indicative of future results.

 

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