What is commodity hedging?

Hedging refers to a strategy of reducing risk exposure. This is done by taking an offsetting position in a closely related product or security. Hedging against investment risk means strategically using derivatives to offset the risk of any adverse price movements.

Types of hedges:

• Perfect hedge: A position undertaken by an investor that would eliminate the risk of an existing position, or a position that eliminates all market risk from a portfolio. In order to be a perfect hedge, a position would need to have a 100% inverse correlation to the initial position.
• Imperfect hedge: The hedger’s gain and loss in the spot and futures market are not fully offset and the hedger will end up with some gain or loss.
• Long hedge: A futures position that is entered into for the purpose of price stability on a purchase.
• Short hedge: A short hedge protects investors or traders against price declines.