The long and short of it

Are you long or are you short? When looking to use derivatives such as futures or options, the first thing you need to understand is whether you are naturally long or short the commodity you are looking to hedge.

Long
If you are long, you have ownership of a commodity that you may need to sell at a later date to generate cash flow. A wool grower is naturally long wool and needs to sell the wool to generate cash flow.

If you are naturally long a commodity, you have a natural market requirement to sell that commodity at some point in time. If you need to sell, you don’t want the market value of your commodity falling before you actually sell it.

To hedge a natural long position, you may be interested to execute a short hedge strategy to offset your market risk. A short hedge is one in which you are looking to sell futures directly or indirectly by using options.

Long Examples Market Risk Short Hedge Examples

 A grower with a clip to sell.

 Falling wool prices Sell futures

Buy put options
 A trader that has bought more wool than sold. Falling wool prices

Sell futures

Buy put options

 

A bank that has financed a grower's wool programme.

 

 Falling wool prices

Sell futures

Buy put options

Short
If you are short, you do not have ownership of a commodity that you need and therefore will be looking to buy at a later date. A wool processor is naturally short wool and needs to buy wool year round to keep the plant operating. 

If you are naturally short a commodity, you have a natural market requirement to buy that commodity at some point in time. If you need to buy, you don’t want the market value of your commodity requirement to rise before you actually buy it.

To hedge a natural short position, you may be interested to execute a long hedge strategy to offset your market risk. A long hedge is one in which you are looking to buy futures directly or indirectly by using options.

Short Examples Market Risk Long Hedge Examples
 A wool processor needs to buy the wool. Rising wool prices

Buy futures

Buy call options
 A trader that has sold more wool than bought. Rising wool prices Buy futures

Buy call options
 A grower who has forward sold more than can be produced. Rising wool prices

Buy futures

Buy call options