What Is Hedging? How Futures and Options Offset an Existing Risk

Hedging is taking a second position that tends to move opposite to a risk already held, so a loss on one is partly or fully offset by a gain on the other.

A hedge starts with an exposure someone already has: a crop to sell, fuel to buy, shares already owned, or income in a foreign currency. The hedge is added to reduce what a price move can do to that exposure, and it has a cost, either a fee paid up front or gains given up. This page explains how hedging works with futures and with options, works through both by hand, covers the costs and the risks a hedge leaves behind, and shows where hedgers appear in public market data. It is descriptive throughout.

The idea: an offsetting position

Every hedge has two legs. The first is the existing exposure. The second is a position chosen because it tends to gain when the first loses. If the two moves were exactly equal and opposite, the combined result would not change with the price at all, which is called a perfect hedge. Real hedges are rarely perfect, because the hedge and the exposure are seldom exactly the same asset, amount and date.

The size of the hedge relative to the exposure is called the hedge ratio. Hedging all of a crop is a ratio of 1; hedging half of it is 0.5, which leaves half the price risk in place.

Hedging with futures: a worked example

A futures contract fixes a price today for a delivery later, which makes it the classic tool for producers and users of commodities.

Take a hypothetical corn grower who expects to harvest and sell 10,000 bushels in the autumn. In spring, futures for autumn delivery trade at $4.50 a bushel. The grower sells futures covering 10,000 bushels at $4.50. For simplicity, assume the local cash price the grower receives at harvest equals the futures price.

Whatever the price does, the combined result is $45,000, which is $4.50 a bushel. The hedge removed the risk of a fall and, by the same arithmetic, gave up the gain from a rise. That trade-off is the core of a futures hedge.

Basis risk. In practice the local cash price and the futures price do not move exactly together. The gap between them is called the basis. Suppose at harvest futures fall to $4.00 but the local cash price falls to $3.90. The crop then sells for $39,000, the futures gain is still $5,000, and the combined result is $44,000, not $45,000. The hedge removed most of the price risk, and the remaining $1,000 came from the basis.

A futures hedge also needs cash along the way. Futures gains and losses are settled daily, so if prices rise before harvest the grower posts margin on the futures loss before the higher crop price is received (see what leverage and margin are). A hedge held over several months may also be rolled from one contract month to the next, at a price that depends on the shape of the curve covered in contango and backwardation.

Hedging with options: a protective put

An option gives a right rather than an obligation, so it can limit a loss without giving up all of the gain (see what calls and puts are). A put that is bought to protect shares already owned is called a protective put.

Take a hypothetical holder of 100 shares bought at $50, worth $5,000. The holder buys one put with a $45 strike for $2.00 a share, which costs $200 for a contract covering 100 shares. At expiry:

Below $45 the loss stays at $700: $500 from the fall to the strike plus the $200 premium. Above $45 the shares keep their gain, less the premium, so the combined position breaks even at $52. Compared with the futures hedge, the put keeps the gain from a rise and costs a known amount up front. The premium usually rises with implied volatility (the size of moves the market is pricing) and with time to expiry, and how it responds to each is what the options greeks describe.

Other common hedges

• Currency hedges. A company due to receive euros in six months can agree today on the dollar amount it will receive, using a forward contract. A fall in the euro then does not shrink its revenue in dollars, and by the same arithmetic it gives up the gain if the euro rises.
• Short positions against a holding. Selling short a stock index future or fund against a stock portfolio offsets part of a fall in the market as a whole, while leaving the risks specific to each stock in place.
• Dealer hedging. Options dealers and market makers hedge the positions their customers leave them with by trading the underlying shares or futures, and adjust that hedge as prices move. Dealer gamma exposure estimates how much that hedging has to change for each move in the market.

Who hedges: the commercial category in futures data

Hedgers leave a public footprint in the CFTC's weekly Commitments of Traders report. Traders whose positions are large enough to be reported to the CFTC are sorted into categories. A trader's positions in a commodity count as commercial when it uses futures in that commodity for hedging. A trader usually enters that category by filing a statement that it is "engaged in business activities hedged by the use of the futures or option markets." In the original, or legacy, report this category also includes swap dealers: banks and dealers hedging contracts they have written privately with clients, outside an exchange, which is called over-the-counter.

Kresmion's free COT positioning tool shows the commercial net position next to the speculator net position for a set of major futures markets. In the report for positions held on Tuesday 22 September 2026, commercials in COMEX gold held 57,458 contracts long and 320,361 short, a net short of 262,903 contracts (futures only). A short futures position is the side a producer hedging future sales takes, as in the corn example. In gold, though, most of that commercial short belonged to swap dealers. The CFTC's more detailed disaggregated report, which splits the commercial group apart, showed producers and merchants net short about 27,000 contracts on the same date and swap dealers about 236,000.

What COT net-long positioning is explains how to read the rest of the report. The free futures curve tool shows delivery-month prices, contract by contract, for the commodity futures it tracks: the prices a hedge like the grower's is placed against.

Honest limitations

The worked examples are hypothetical and leave out commissions, bid and ask spreads, taxes and the interest cost of margin. A hedge reduces one risk and can add others: basis risk, the risk that the other side of an over-the-counter contract fails to pay, and the cash strain of margin calls. A hedge sized for an expected amount, such as a forecast harvest, can be too large if that amount falls short, leaving a position that no longer offsets anything. Accounting and tax treatment of hedges is a specialist subject this page does not cover. The COT figures are weekly and published days after the positions date, and the commercial category describes how a trader is classified, not the purpose of every contract it holds.

Key takeaways

Frequently asked questions

Is hedging the same as speculating?

No. Hedging starts from a price risk that already exists and adds a position to reduce it. Speculating takes on a price risk in the hope of a gain. The same futures contract can be either, depending on what else the holder owns: the grower's short futures position is a hedge, while the same position held by someone with no crop is a speculation.

Can a hedge lose money?

Yes, on its own. In the futures example the hedge lost $5,000 when corn rose, and the put in the options example expired worthless above $45. A hedge is judged with the exposure it protects, and in both examples the combined results spread over a narrower range than the exposure alone. The hedged crop brought $45,000 in every case, against $40,000 to $50,000 unhedged. The hedged shares ran from a loss of $700 to a gain of $800, against a loss of $2,000 to a gain of $1,000 unhedged. The combined position can still lose, as the put example does below $52, and basis gaps, costs or a wrongly sized hedge can add to that.

What is a perfect hedge?

A hedge that offsets the exposure exactly, so the combined value does not change with the price. It needs the hedge to match the exposure's asset, amount and date, which is rare outside simple cases.

Why do hedgers give up gains?

Because the hedge is the mirror image of the exposure. A futures hedge that gains when prices fall must lose when they rise. A bought put avoids giving up the gain, but at the cost of the premium paid up front.

Does a big commercial short position in a futures market predict prices?

No. It shows how hedgers were positioned on a past date, which reflects their business exposures. It is a description of positioning, not a forecast.

This page is information, not investment advice.

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Source: US Commodity Futures Trading Commission, Commitments of Traders explanatory notes, https://www.cftc.gov/MarketReports/CommitmentsofTraders/ExplanatoryNotes/index.htm ; CFTC, Disaggregated Commitments of Traders explanatory notes, https://www.cftc.gov/MarketReports/CommitmentsofTraders/DisaggregatedExplanatoryNotes/index.htm ; CFTC Disaggregated Futures Only report, COMEX gold, 22 September 2026, https://publicreporting.cftc.gov/Commitments-of-Traders/Disaggregated-Futures-Only/72hh-3qpy ; CFTC Commitments of Traders report, COMEX gold, positions as of 22 September 2026, via the Kresmion COT positioning tool, https://kresmion.com/tools/cot-positioning ; futures and protective put examples computed by Kresmion for hypothetical positions ; Kresmion futures curve tool, https://kresmion.com/tools/futures-curve.

Kresmion Research.