Introduction to Hedging
If you are new to the market and want to learn what hedging is all about, then you have come to the right place. Like all industries, the financial market has its fair share of industry jargon. While every attempt has been made to limit the jargon used in this material, it is unavoidable that some jargon will be used. In such a circumstance, you may find the useful to explain a term used.
Wool marketing and risk management is interesting and challenging in that there is plenty to learn and everyone in the market is constantly learning. Some might say that derivative products such as futures and options are not for everyone, but everyone owes it to themselves to at least know what these products can do and the role they will play in Australia's wool market.
About ASX Wool Futures
The operation of the wool market presents growers, local merchants, local exporters and offshore mills with different price risk scenarios:
- Growers are exposed to the risk of low wool prices. They need to manage cash flows to meet financial obligations relating to operational and maintenance costs, production costs, and financial charges.
- Local exporters are exposed to the risk of high wool prices. They need to manage their gross margin which is the difference between buying from growers and merchants at uncertain and volatile prices and selling to overseas markets.
- Local merchants may be exposed to the risks of both high and low prices. They need to protect their positions, and subsequently their profits, through the process of hedging.
- Offshore mills, similar to local exporters, are exposed to the risk of high wool prices. They need to manage uncertain and volatile wool prices to control the input costs of their milling operations.
To alleviate these risks the above parties can enter into financial contracts (futures) to fix the sale or purchase price of wool in advance. This provides certainty, as the profit/loss made on the financial contract should offset the impact of unfavourable/favourable movements in the physical market.
About Wool Options
Options are available to trade over SFE Greasy Wool 21 micron Futures. Options are listed over the two nearby futures contracts at anytime. Options provide both buyers and sellers with an alternative marketing tool.