Apr 29

Long hedge with copper futures contract - 10 min. screencast

by David Harper, CFA, FRM, CIPM

This illustrates how a company which depends on copper as an input (e.g., a computer maker) can use copper futures contracts to hedge its exposure (the anticipation of copper spot price increases). The exaggerated example assumes the current copper spot price is $4 (green circle) and the one-year futures contract is priced at $3.80/lb. A long position is a contractual agreement to purchase the copper one year forward at the agreed-upon price of $3.80; this is backwardation as future price < spot price.

An important assumption (finding strange, recent violations) is that the futures contract price must converge with the spot price as the contract approaches expiration (delivery date). Or, specifically, the futures price should convergence to a zone around the spot at delivery.