CHART 1_About sugar buying for jobbers

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HEDGING

to protect a normal jobbing profit by eliminating the probability of

a speculative loss or gain

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Initial | |

Transactions| Subsequent Transactions | Result

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| | |cover| way | way |

| | |-ing | | |

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at 6.00 | sugar (or |to 4.00 |4.00 |2.00 |6-2=4 |

hedge by | |to 8.00 |8.00 |2.00 |6+2=8 |is made.)

same amount | | | |No | |

at 6.00 | |6.00 |6.00 |no loss|cost |

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Naturally the greater the amount of sugar any one concern may have in

transit the greater the need for protection. We call this kind of

transaction particularly to the attention of buyers having branch

houses who find themselves obliged to make relatively large purchases

to supply their trade in the face of a market in which they have no

confidence.

These disadvantages at which out-of-town buyers are sometimes placed

might be overcome by using the Exchange. On the other hand, when

refiners are badly behind on deliveries, even buyers located at the

source of supply will find themselves facing a similar problem the

solution of which may be found in a use of the Exchange.

It is therefore evident that the selling of futures may be a transaction

the _sole_ purpose of which is to eliminate speculation from a jobber's

business.

Regardless of how careful a buyer may be, there is an element of

_speculation in each purchase of actual sugar_.

If the price goes up, there is a speculative gain--the sugar is worth

more. But if the price goes down, the buyer sustains a speculative

loss.

The measure of protection afforded by the Exchange will appeal to those

jobbers who wish to reduce the speculative element in their business.

In the example immediately following, as in all others, we have not

taken into consideration the difference between the Exchange quotations

and the Seaboard Refiners' quotations, which is explained on page 38.

This would simply inject an unnecessary complication, and would be of

no particular advantage for purposes of illustration.

Suppose you should buy through your broker from a refiner, for prompt

shipment, an amount of _actual_ sugar at 6.00, which you plan to sell

within a short time after its receipt. Instead of worrying about

subsequent sugar price fluctuations, you simultaneously hedge this

purchase by _selling_ futures in the same amount on the Exchange. The

price at which you buy actual sugar and the price at which you sell

futures should be relatively the same, since Exchange prices generally

reflect refiners' prices.

You should be able to figure the cost of your sugar at about the market

price at the time it is received or sold. (See Chart 1.)

If the price of sugar should go down to 4.00 at about the time when you

sell it, your actual sugar, for which you contracted to pay 6.00, would

be worth only 4.00; but you would then buy to cover your futures sale,

making 2.00 on this transaction, which, subtracted from the price you

paid (6.00), brings the cost down to the market price of 4.00. In other

words, you have accomplished your purpose of being able to figure your

sugar cost at the market price at the time when you received it (or at

the time you sell it). That is, although every pound of actual sugar

was sold at a loss, this loss was balanced by the profit from your

hedge.

If, on the other hand, the market should advance to 8.00 after your

original purchase and hedge at 6.00, the value of your actual sugar

would be increased by 2.00. You would then buy futures at 8.00 to cover

your short sale at 6.00, netting a loss thereby of 2.00. This loss

would be added to your original cost of 6.00, making your actual sugar

cost 8.00, which is the market price at the time. Had you omitted the

hedge, your sugar would have cost you only 6.00, but, in this example

we are assuming that you would sell only when you were willing to

figure your sugar cost at the market price. This you have accomplished

by foregoing the speculative profit you _might_ have made in favor of

your normal jobbing profit.

If the market should remain relatively stable you would buy to cover

your hedge at approximately the same price as you sold for, your gain

or loss being practically nothing. In other words, you would obtain

sugar at the market price, which is the purpose in this kind of a

hedge.

HEDGING _to protect a gain on a favorable purchase of actual sugar_.

All sugar buyers have had the experience of buying actual sugar, only

to see it advance or decline before they have disposed of it. How to

protect the gain, or minimize the loss, is described in the two hedging

positions which we now discuss.

Suppose you have bought sugar, have _not_ hedged against it, and have

seen it advance. Finally you have said, "I think sugar is about as high

as it is going. I am going to sell against that to protect that

profit."

On the other hand, the reverse might be the case. You might find the

market going down, and say, "The market is going lower. I want to hedge

against that, and limit my loss to a definite amount."