Futures and option

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CROSS HEDGING 3

Cross Hedging

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The futures market is a place where investors and sellers promise to purchase or sell things at a certain price and on a future date they've agreed upon.

The most interesting concept I found is the cross hedging also known as, Crossover hedging, involves purchasing another instrument whose price fluctuates to reduce the danger associated with the one that is being traded. What attracted me the most is, when companies and buyers fail to come up with suitable hedging contracts, they step away from the commodity altogether. For cross-hedging, a close relationship with an asset is needed.

In order to get a clearer idea about cross hedging lets take an example of jet fuel price. It is very fascinating to see that trying to protect from jet fuel price is a widespread corporate strategy. Furthermore, as companies have no potential options on jet fuel, their primary risk-management technique is to invest in the spot market. The jet fuel price can be linked to the crude price of oil. Due to these hedge purchases they limit financial profits and losses in the case of increasing crude oil costs, but not jet fuel rates. There is a question that came to my mind, how about a hedge to avoid failure on one side of the portfolio from the gains on the other? After extensive research I found the answer that speculates as you put on a cross, for instance, two similar assets/securities or goods, hoping that their values would rise together or fall together. When you invest in only one of the assets, you put all your eggs in one basket, as it were.

For real case implementation of this topic, here is an example. In this case, the item's price is fixed now, although the distribution would occur at a future date. Futures are appropriate in the context of assets that companies or other institutions might invest in, will grow or decline in value; they help protect against a rise or fall in asset price. To fill this gap, the use of cross hedges is often unavoidable. In the absence of a perfect hedge, firms look for the nearest substitute. The challenge is to identify a commodity in the market with a positive price movement that we can acquire.

Additionally, though, in companies, no matter how careful you are, you can never eliminate all the threats. The market movements of the two commodities could not always be positively correlated. Here you will see that you might confidently predict that both gold and platinum prices will drop in the illustration you provide. However, prices of platinum might rise when the prices of gold are dropping. So I think that then you can lose money on gold but still pay more for platinum.