Hedging future with option hedging option, hedging future, future, stock market

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Hedging future with option

Stock market has great fluctuations every second and this may cause problem for the traders to decide whether to use settlement price or the present spot price of the underlying asset. To remove this difficulty the concept of hedging was devised.
Hedging Future is a primitive way of trading in which buyers and sellers keep with the settlement prices. And by chance if there is some hike or fall in the price of that asset both the parties will have to retain their contract and do business on the settlement price. This may cause some disputes among the traders. For example if you buy some asset at $ 30 from some buyer and settle the price at $30 but a few days later after the delivery of the asset the price of the asset hikes to $35 in the stock market. The buyer will insist on the new spot price while you will try to buy the asset at the settlement price as decided by the future contract. This causes disputes among traders and due to this reason a new concept was required to minimize this confusion of actual spot price and the settlement price.

To remove this confusion Hedging option was put forward. According to this concept the agreement is made earlier but the price of the underlying asset depends upon the actual spot price at the time of payment. For example, if you made agreement with some gold maker to buy 5 kg of gold at price $1000 per kg from him so no doubt you confirmed the contract but after a few days the price of gold hikes to $1050 per kg so according to option contract you will have to pay $ 1050. So, this removes the confusion of derived or settlement price or actual price.

For this reason, hedging options is preferred to hedging future and hedging future is becoming less popular due to its problematic rule of hedging. New traders and even the old bulls of the market are preferring option hedging to future hedging. And it is totally fair, business has a rule of doing business without being complexity but future hedging was creating problem for the traders and so option hedging was devised which is more useful for the traders. One day may be option trading will completely take over future hedging.