What Is a Long Hedge?

A long hedge is a futures position taken to stabilize purchase prices, primarily used by manufacturers and processors to mitigate price volatility when acquiring necessary inputs. These companies anticipate the need for materials throughout the year and employ long hedges to ensure price stability across multiple purchases.

Also known as input hedge, buyer’s hedge, or purchasing hedge, a long hedge serves as a strategy to manage costs and reduce risks associated with price fluctuations in the procurement of commodities.

Understanding Long Hedges

Long hedges are employed by companies looking to secure future purchases at a set price. By entering a long futures position, the buyer bets on price appreciation of the commodity. If the commodity price rises, the profits from the futures position offset the increased purchasing cost, thereby providing a cost-effective solution.

Example of a Long Hedge

Let’s illustrate a long hedge scenario: an aluminum manufacturer in January needs copper to fulfill a contract due in May. If the spot price is $2.50 per pound and the futures price for May is $2.40, the manufacturer can secure a long position in a May futures contract for copper, potentially hedging part or all of the expected order.

The hedge ratio, determined by the size of the futures contract relative to the purchase order, influences the effectiveness of the hedge. If the May spot price exceeds $2.40 per pound, the long position benefits the manufacturer by offsetting higher purchasing costs. On the other hand, a lower spot price means a minor loss on the futures contract but savings on the purchase price.

Long Hedges vs. Short Hedges

Long hedges play a crucial role in managing pricing risks, with a high hedge ratio minimizing basis risk. In contrast, short hedges protect sellers by fixing sale prices. Both long and short hedges act as a form of insurance, incurring initial costs but potentially saving companies from significant losses in unfavorable market conditions.