What should the Crabtrees do to provide protection from rising soybean meal prices if they plan to buy in May next year?

What should the Crabtrees do to provide protection from rising soybean meal prices if they plan to buy in May next year?

• A. Buy May soybean meal futures contracts today, expecting to sell them in May
• B. Sell May soybean meal futures contracts today, expecting to buy them in May
• C. Buy May soybean meal options, expiring in May
• D. Do nothing

Answer: (A)

Taking a hedge with futures to lock in the expected purchase price is the idea. Because they plan to buy soybean meal in May, they should go long May soybean meal futures now. If prices rise by May, the value of the long futures position increases, offsetting the higher cash price they’ll pay for the meal. In May they would close the hedge by selling the May futures contract, effectively locking in the price they’ll pay. Buying options could also protect, but they involve paying a premium and don’t guarantee the same price lock. Doing nothing leaves them exposed to rising prices.

Taking a hedge with futures to lock in the expected purchase price is the idea. Because they plan to buy soybean meal in May, they should go long May soybean meal futures now. If prices rise by May, the value of the long futures position increases, offsetting the higher cash price they’ll pay for the meal. In May they would close the hedge by selling the May futures contract, effectively locking in the price they’ll pay. Buying options could also protect, but they involve paying a premium and don’t guarantee the same price lock. Doing nothing leaves them exposed to rising prices.