Published on: 17:09PM Aug 30, 2010
In a true traditional hedge, you sell futures against your cash position when prices are at a level you can live with and you leave that short position in place until you deliver cash grain. With today’s volatile markets, some farmers are reluctant to use futures due to the possibility of very large margin calls and the cash-flow they require.
Another choice is to place your hedge but employ protective stops to get you out of them if the market moves the wrong way, says Jim Wyckoff of Synergistic Trading, a long-time technical analyst. In this case, you would place buy order above your sell position.
Where to place your protective stop is the tricky part. Too high and you lock in a painful loss. Too low and you may get bounced in and out of the market a lot, gathering trading costs along the way.
Wycoff suggests one way to decide is to use technical analysis to identify a resistance level—if the market makes it through that level, it would indicate a change in trend and possible continued upward move. Because many traders use the same chart signals, you may want to set your order a few cents before the resistance level.
Another method would be to decide how much of a loss you are willing to accept per contract. Say you have a 5,000-bu. corn contract and you don’t want to lose more than $250. Then you would allow about a 5¢ move.
“If the market falls and profits begin to accrue, you may want to employ ‘trailing stops,’ adjusting your protective stop downward to protect those profits,” he adds.
Keep in mind that in a hedge, your futures “loss” is being offset by an opposite move in the value of the cash commodity. So the margin you pay out is just a paper value until you close the hedge position—and even then, you get the price you locked in originally. (Of course with the unpredictable basis we have had recently and cash prices not keeping up with futures, that may NOT be the case.) If you get out of a hedge on a stop, accepting a small loss, and prices then collapse, you may lose in both the futures market AND cash markets. If you stayed in and the market turned, your only cost would be the interest.