Hedging with futures.

Hedging is why futures markets exist, and the Series 3 tests it heavily. A hedge uses a futures position to offset the price risk of a physical commodity you own or will need. The two directions to know cold are the short hedge and the long hedge.

Short hedge — for sellers/producers

Someone who owns or will produce a commodity (a farmer with corn, an oil producer, a manager holding bonds) is hurt if prices fall. They sell futures now to lock in a selling price. If the cash price drops, the loss on the physical is offset by a gain on the short futures.

Long hedge — for buyers/users

Someone who will need to buy a commodity later (a food manufacturer, an airline buying fuel) is hurt if prices rise. They buy futures now to lock in a purchase price. If cash prices climb, the higher cost is offset by a gain on the long futures.

Basis and why hedges aren't perfect

Basis is the difference between the local cash price and the futures price. A hedge protects against the big directional move, but because basis can change before delivery, the offset is rarely exact. That leftover exposure is basis risk — a favorite exam concept.

The mental model

Ask two questions: does this person have the commodity or need it, and which price move hurts them? Producers fear falling prices (short hedge); users fear rising prices (long hedge).

Practice hedging scenarios with the free questions, or brush up in the Series 3 guide.