Hedging is a process that a business can use to manage volatile commodity prices and is often referred to as Price Risk Management.
Businesses involved in producing or consuming commodities e.g. grain need to be able to hedge to protect profit margins from violent swings in the grain price – volatility.
Hedging in agriculture is important because of the reliance on commodity markets, which can be highly volatile. Also, the production time scales involved add further risk as it gives a wide period of time within which volatility can occur.
From a pig producer’s perspective, hedging allows them to protect their business from increases in grain price. In its simplest form, a hedge for a pig producer involves buying grain or feed forward and so fixing raw material costs.
Either directly or indirectly, hedging works best by the use of futures or options. Using futures and options directly would require the producer to open their own trading account with a registered broker, which requires some cash flow, time and fulfilment of financial regulation checks. Indirectly, a pig producer could access these tools via a feed supplier. In the example above where the producer is buying feed forward, the supplier can hedge this requirement on the futures market