In futures trading, both end-users of raw materials and traders participate.
The first group aims to hedge their business margins, while the second seeks to profit from price fluctuations.
However, there are cases where a transaction is perceived as a hedge, but in reality, it’s speculative—and carries significant risk.
Below are three real-life scenarios that illustrate the difference:
🔶 Scenario 1: Finished product is sold, but raw material is not yet purchased
For example, a real estate developer starts selling under-construction apartments. Sales begin, prices are fixed—but rebar (steel) is not yet purchased. It will be bought periodically, but prices remain volatile.
👉 Risk: If rebar prices rise, your costs increase, and your margin shrinks.
✅ Hedge: Go long on futures. This locks in the purchase price today and protects your margin.
If rebar prices go up, losses in the core business will be offset by gains on the futures.
If prices drop, the futures will generate losses, but your raw material becomes cheaper.
➡️ Key Insight: Without hedging, your expected profit range is wide—both upside and downside. Hedging narrows that range, containing both risks and opportunities within a band.
🔶 Scenario 2: Long-term contract with LME + X% margin
For instance, a cable manufacturer signs a long-term agreement with a distributor. The distributor commits to periodic purchases of a fixed volume, priced as LME + X% (LME – London Metal Exchange).
👉 Risk: Fluctuations in LME can impact your margins, especially if you’ve already procured inventory and LME prices fall.
✅ Hedge: Go short on futures. This locks in the LME price and secures your X% margin regardless of market moves.
🔒 Just like in Scenario 1, your margin is protected.
🔶 Scenario 3: You haven’t sold yet, but fear raw material prices will fall
A cable manufacturer, fearing a drop in copper prices and being stuck with expensive inventory, opens a short futures position.
But is this truly a hedge?
👉 What happens if copper prices rise further?
The value of your relatively cheap inventory will increase—but your futures losses will cancel out the benefit. Worse, since you haven’t locked in any sales, the market may shift to a competitor who didn’t hedge—and now has better pricing flexibility.
⚠️ Key Lesson: If your hedge isn’t tied to a physical position, it’s no longer a hedge. It’s speculation.