All right, so now on this final video for our course, what I'm going to do is give you a quick overview on hedging with futures and futures options. If you want to learn a little bit more about how this is actually done, I've got a more in depth tutorial on how we work with things. And when we work with clients. We go through a very in depth discussion we take a look at, for example, a business's operations let's say for example, it were a farmer that we're looking to go ahead and sell their crop their soybeans and corn livestock. And what they're doing is are they're going to go and produce those but they're worried about the prices of their end product going down which case they make less money on the selling price. Well, in that case, what they need to do is have Or use futures and options to manage the price risk of their actual end product prices going down, lowering the profit margins.

By contrast, let's say for example, you're a refinery, let's say you're working with gasoline, and you're refining our gasoline, you buy crude oil to find that to your end product. Well, when you buy crude oil throughout the course of the year, the main concern that you have is a rise in crude oil prices. And so you're taking the opposite stance where when we talk about the farmer, we're worried about falling prices, falling your end product and selling price. In this case, when we're talking about a refiner, and you're buying crude oil as an input product, you're worried about price going higher. So what can you do to manage these types of price risks? So to start off here, we're taking a look at the Chicago Mercantile exchanges website CME group's website, and you've got all the different categories of commodities up here.

You've got everything from agriculture, energy, equities, and Move down further, you've got foreign exchange interest rate products, and metals. So hedging or speculation can be done on a variety of different types of asset classes here. Alright, now for our purposes, what I'm going to do as our example, is we're going to take a look at corn. Okay, so with corn, we've got, you know, the farmers that grow it weed, they grow soybeans, corns, and typically, you know, the corn that's grown and sold over here as a commodities is the bulk of its use for animal feed, and for producing ethanol. And it's different from what we have in terms of, you know, buying corn off the grocery store, the human, sweet bass corn, it's a little bit of a different type of court. The ones that we deal with over here from commercial grade is more the type of corn that's used again for animal feed.

So let's take a look at this. What is a bushel corn? What is it that we're actually selling? So here's a quick article. When you look at corn prices, you'll see Something like 350 or 867 for soybeans, for example, and what does that actually mean? Well, this 350 is actually quoted in US cents.

So when we say 350 cents, we're really looking at $3 and 50 cents for a bushel. And what is a bushel corn? Well, after the farmer, basically harvest and shells off the corn, you can imagine this as a giant bucket over here, and this bucket weighing approximately 56 pounds, this represents one bushel of corn. Now, if you can remember back to our lesson one, where I showed a matrix on the right hand side of units, left hand side of contracts for futures, and we start talking about crude oil. So one barrel of crude oil. In terms of the physical unit when we talked about that on futures, it was 1000 barrels of crude oil for one futures contract.

Well, how it works for the grain markets mainly for corn, soybeans, for wheat, is that one contract on the future side 5000 of these bushels, so one contract of corn would be 5000 of these giant 56 pound buckets of corn. Okay, so if we were looking at, let's say, for example, corn being at $3 and 50 cents a bushel, times 5000, the value of a corn contract would be $17,500. Alright, so for purposes of our hedging example, let's pretend that you are an ethanol manufacturer. And so what you basically do is you buy raw corn over here, and then you process the corn at your facility to produce ethanol and you sell ethanol. So the corn that you buy from all these farmers is a cost input going into your ethanol factory, and what's you're concerned about is that corn prices could go higher. So for example, even like right now, given the tariff situation, with In the United States right now, there is the possibility that there might be a deal with China.

And let's suppose with that deal, corn prices are expected to pop all the way up over here. Okay, so in this case over here, we're now looking at a current chart. And in this particular case, we see corn price at $3 and 90 and a half cent per quart. And that's $3 and 90 cents for one bushel. And let's say for example, you as an ethanol facility need to buy 5000 bushels for your next run. And just a quick side note, so you see over here, you've got $3 and 90 cents, yet an apostrophe and a little six after that.

Well, on the futures markets, how corn prices move is a move quoted as an eighth of a cent. So you'll see this go as to waste 4868 and a full point. And the reason I say goes to 468, is because for the futures that moves in cortex, so two aces, a quarter for eight and a half Six as three quarters and then a full point. So you'll see it move that way. And if you look at a quarter tick moves, so let's say for example, went up to 82 divided by eight, that's one quarter. Now it's one quarter of a cent, because this is $3 and 90 cents.

And then of course, in this case, it's three quarters of the set. But let's say it's two ways. That's one quarters of a cent. You divide that by hundred, since it's a cent. And then if you were to multiply that by 5000 bushels, you will see this as $12 and 50 cents. So for every tick here on the futures two ways, or it's six days, each tick is 12,050 cents per contract.

Okay, so in this case, anyway, what we're going to do is we're going to work with hedging 5000 bushels of corn. We're an ethanol producer, and we're buying corn from a farmer and we're worried that the price of corn might go higher from $3 and 96 eight cents to say, for example, $4 and 30 cents. So what would that actually mean? So to put it in perspective, for a simplified example, let's say $4 and 30 cents a bushel, and we'll just estimate it, let's say minus $3 and 90 cents, roughly where it's about now, so about a 40 cents a bushel times 5000 in a contract, or what we're trying to hedge that's $2,000. So for each contract here, of 5000 bushels, if the ethanol factory doesn't do anything, and all of a sudden price goes higher by a time the rate of purchase is somewhere around $4 and 30 cents a bushel.

This ethanol plant could be buying or having to spend an additional $2,000 for each 5000 bushels of corn, and just something on the side. So each bushel of corn makes about 2.8 gallons of ethanol. So if you're looking at 2.8 gallons, of ethanol, times 5000 bushels and corn futures contracts about 40,000 gallons of ethanol. Alright, so now we're going to take a look back here at quick strike. And what I've done here is I've simulated where we're at in terms of us being a fire with the ethanol plant, and also looking to purchase physical corn at some point in the future for production. And so this represents $3 and 91 cents or close to there abouts.

And let's suppose prices were to increase what price were to increase, that basically means our costs go higher. And so the reason you see this as a short position, or this downward sloping action here is that basically we're taking an implied loss if the price of corn goes higher, right, and so what we need to do is we would have to end up paying more that's more money out of our pocket, and that's why this shows here as a loss. So what we could do is a couple of strategies. We could buy a call option. Or we could maybe purchase a futures contract. So then if the price of corn is shown down here on this bottom axis here, that the price of corn were to go higher, you would have a gain on the futures contract, which would offset the loss of here.

Another type of strategy could be simply buying a call option. So let's take a look at what that is by where, for example, to purchase a 390 call, and just put this here as a 390 call, what would that look like? So here you can see what happens is that as prices rise, it basically will offset the increase in costs. So let's take a look at simulation and you can kind of get a sense of what that actually means. So let's say for example, with this up fast arrow, so here's basically where we're at in price close about $3 and 90 cents or $3 91 cents. So what would happen if prices were to rise up here?

So what Basically happens is as price goes higher, you're able to offset that increase in cost with the hedge. And that's what you see here in the chart. What's easier if we just take a look down at the actual summary here. So if we look at this line here for the physical corn on the physical corn because prices went higher, we'd have to outlay close an additional 1600 dollars in cash based on the increase in price on corn. Okay, but because we have hedged with a strategy in terms of buying a call option, we actually made close to about 1100 dollars on the call option, okay, and so 1100 dollars gain on the call option, offset the additional costs that were granted, you know, use or pay for physical corn. So really, really our net additional expense over here or for cost, it could be as close to $424.

Okay, so that's basically in a nutshell, what hedging is all about. That's really what I wanted to illustrate in this particular presentation. Now, this can be done pretty much across the board for any commodity, you could even be done for foreign exchange. So that's used quite a bit. So if you're using for example, if you're a business that's exporting out to, let's say, some somewhere in the European bloc, and you could actually work with eurodollar futures, same thing with the pound dollar, or you're working with the Chinese Yuan, you could work with that or the Japanese yen. There's ways to go about that.

In terms of hedging. In any event, I just want to mention that we are welcome Kappa group is a registered commodities trade advisor registered with the National futures Association. And we do focus it's specialized on hedging and the process of hedging can be fairly complex, we can actually work with pretty much any type of product on hedging. And what I mean by that is one of the key elements you look at this is a little beyond the scope of this video. entation is what we call correlation. And what that really means is we can take a variety of different futures products and futures markets.

And we have the ability to create a matching correlation of price movement on the derivative markets pretty much don't match a lot of different other products around the world. So for example, manufacturer working with cardboard boxes, there's no futures market for cardboard boxes, but we are able to create a derivative type of correlated hedge that can help match that so just wanted to throw that out there in case anyone out here listening to speed station has a business wants to learn more about how hedgy can work with managing price risk in their operations, we're able to help out. Alright, so that's basically it for this lesson. If you have any questions, again, please feel free to give us a call. And we hope that this exercise was helpful. Thanks