Hedging and the speculation myth
Trading houses transfer risk; they don't mostly gamble on price.
Outsiders imagine commodity traders as gamblers betting which way oil will go. Most of the durable business is the opposite: traders try to remove the price bet so they're left earning a spread for logistics, financing and risk transfer. The tool for removing the price bet is hedging.
How hedging works
When you buy a physical cargo you're 'long' the commodity — you lose if its price falls before you sell. To neutralise that, you simultaneously sell an equivalent amount on a futures exchange (LME for metals, ICE and CME for energy and softs, CBOT for grains). If the commodity's price falls, your physical cargo is worth less but your short futures position gains roughly the same amount. The flat price cancels out, leaving you with the spread you set out to earn.
- Long / short
- Long = you profit if price rises (owning cargo); short = you profit if price falls (a sold future).
- Futures
- Standardised exchange contracts to buy/sell a commodity at a set price and date — used to hedge.
- Basis
- The difference between your physical price and the futures price; what's left after hedging.
- Quotational period (QP)
- The agreed window whose average exchange price sets the final physical price — common in metals.
You own a physical cargo and want to remove price risk. Do you buy or sell futures?