Key points
- A hedge presupposes an identifiable, measurable exposure, such as inventory, unpriced contracts or future foreign currency receipts and payments.
- Common instruments are futures, options, forwards and swaps. Commodities are mostly hedged with exchange-traded futures and options; foreign exchange mostly with forward FX settlement and options.
- The hedge ratio, hedge horizon and stop-loss rules should be set in advance in the hedging plan and monitored independently by risk management.
In practice
Hedging in trading companies usually follows the contract: signing a purchase or sales contract, fixing the price, shipping and settling all change the exposure, and the hedge position has to be adjusted to match. If traders hedge on experience in their trading software while the physical data sits in the business system, the two are hard to match transaction by transaction – no one can say which hedge covers which physical deal, and effectiveness cannot be assessed.
The mature approach is “exposure first, instruction second”. Contracts and pricing on the business side create exposure, the system generates hedge recommendations from it, traders place orders against those instructions, and fills are written back to the corresponding hedge relationships. Risk management monitors hedge ratios and deviations in real time, and finance uses the results for combined physical–futures accounting and hedge accounting.
How Tranexio supports it
Tranexio provides hedging strategies, hedge relationships, hedge instructions, hedge positions, deviation monitoring and negative-equity alerts. A hedge recommendation is generated automatically once a pricing takes effect, and the process connects to hedge accounting and combined physical–futures accounting. See Hedging and hedge accounting.