LongHedge

LongHedge is a hedging strategy used to protect against the risk of rising prices for a commodity or asset that a party expects to purchase in the future. It involves taking a long position in futures contracts on the desired asset, with the aim of locking in a future purchase price.

The strategy is commonly used by buyers such as manufacturers, processors, and other entities that anticipate needing to acquire a commodity at a known future date. By entering into long futures positions, the buyer gains price exposure that rises with the market. If the spot price increases by the time of purchase, the gains from the futures position offset the higher cash cost. If prices fall, the cash outlay is reduced, while the futures position may incur a loss, potentially diminishing the benefit of the price drop. In an ideal, perfectly correlated market, the combination of cash price and futures would be roughly price-neutral.

Implementing a long hedge involves estimating the expected quantity to be purchased and selecting futures contracts with a comparable underlying exposure. The hedge ratio, often derived from the value of the planned purchase relative to the size of a futures contract, determines how many contracts to buy. Basis risk—differences between futures and spot price movements—can affect effectiveness, as can factors such as margin requirements, liquidity, and the need to roll contracts as they expire.

Long hedges are contrasted with short hedges, which protect against declines in the price of an asset that will be sold in the future. While useful for risk management, long hedges limit upside gains if market prices fall.