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A Penny Saved Is a Penny Earned: Hedging with Futures

April 18, 2019 by Daniels Trading| Futures 101

In the business world, an element of risk lingers behind almost every choice we make. Whether buying a parcel of oceanfront land or planting corn instead of wheat, there are no guarantees that our decisions will be good ones. Risk is present in everything we do, and hedging with futures helps put the “worst-case scenario” into manageable terms.

Aside from avoiding the pitfalls of excessive leverage and having a sound plan, futures can help mitigate the negative impacts of the unfortunate. Through hedging with futures, checking risk becomes routine.

What Is Financial Risk?

Financial risk is a major concern for business people and investors alike. It frequently destroys wealth and may undermine an otherwise effective marketing strategy. Nonetheless, there’s good news: Hedging with futures can greatly reduce exposure to financial risk.

Financial risk comes in many forms, each dangerous in its own way:

Type of Risk Definition and Impact
Systemic Systemic risk addresses the relative stability of the broader financial system. In the event systemic risk reaches dangerous levels, sudden crashes in equity, currency, or commodity markets become increasingly possible.
Liquidity Liquidity risk refers to the inconvertibility of assets to cash (or vice versa) to limit losses in periods of extreme pricing volatility. This type of risk is common to producers because finished products or commodities may not be readily sold to meet obligations.
Currency Currency risk is specific to investors in foreign monies or assets. In the event fundamental factors negatively influence the exchange rate of the related currency, the value of the holdings decrease. Currency risk is a major consideration for portfolios that hold international assets.
Credit If you’ve heard the term “bankruptcy” — or gone through one — then you’re familiar with credit risk. This type of risk involves an entity not being able to satisfy or restructure debt obligations. Credit risk can prompt a variety of unfortunate events, such as corporate takeovers, asset liquidations, and investor loss.

It’s a hard truth, but business is not conducted in a vacuum. One or all of the risks above may intervene and negatively impact an investment or venture. However, by implementing various hedging strategies, it’s possible to limit the financial damage.

Hedging with Futures Puts Financial Risk in Its Place

Hedging strategies come in all shapes and sizes, from advanced to basic. Below are a few ways that business people from all walks of life use futures to save money when the unexpected strikes:

Type of Risk Futures Hedging Strategy
Systemic To protect against a broad-based market meltdown, investors or producers frequently buy gold futures. Other safe-haven futures contracts, such as silver or the Swiss franc FX, are also used to insulate against systemic failure.
Liquidity One of the premier advantages to futures products is their inherent liquidity. Assume that a person is heavily invested in a mutual fund, ETF, or real estate. Converting the position to cash may be an involved process, including fees and considerable time to execute. By taking either a long or short futures position related to the portfolio’s base asset(s), losses due to transactions costs and adverse swings in asset pricing may be effectively limited.
Currency Implementing a “buy and hold” strategy using foreign currencies is a popular means of investment. In order to reduce the chance of the purchase losing significant value, offsetting positions may be taken in one or more correlated FX currency futures.
Credit Credit risk is a challenge to hedge against, due to its locality. An entity may be in financial distress without showing any signs of trouble before going bankrupt quickly. One way that investors hedge against credit risk is by buying S&P 500 Volatility Index (VIX) futures. During times of extreme market volatility, such as in 1987 or 2008, the VIX rises, as does the  chance of corporate insolvency. In these instances, holding long positions in VIX futures can help to limit losses due to credit default.

Saving Money Is the Name of the Game

No one wins 100% of the time. In order to succeed in the long-run, it’s imperative to minimize losses. Hedging with futures gives business people of all types a way to avoid catastrophe and ensure the best odds of success.

A great resource for all things hedging is Daniels Trading’s online hedge portal. Featuring the DanielsAg mobile app and expert market analysis, it has everything you need to tackle the risks facing your business.

Ready to think like a technical trader? Download our free guide to learn how to identify chart formations and take action when the time is right.

Filed Under: Futures 101

About Daniels Trading

Daniels Trading is an independent futures brokerage firm located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading is built on a culture of trust committed to the firm’s mission of Independence, Objectivity and Reliability.

Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

GLOBAL ASSET ADVISORS, LLC (“GAA”) (DBA: DANIELS TRADING, TOP THIRD AG MARKETING AND FUTURES ONLINE) IS AN INTRODUCING BROKER TO GAIN CAPITAL GROUP, LLC (GCG) A FUTURES COMMISSION MERCHANT AND RETAIL FOREIGN EXCHANGE DEALER. GAA AND GCG ARE WHOLLY OWNED SUBSIDIARIES OF STONEX GROUP INC. (NASDAQ:SNEX) THE ULTIMATE PARENT COMPANY.

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