Suppose you are a farmer that grows soybeans and are approaching the harvest. You won't be able to sell your harvest in the market until January (3 months). You are thus long spot soybeans.

You have the following information:

Spot is 1050

January futures are 1060

January 1060 calls cost 5

January 1060 puts cost 5

Interest rates are 5% simple interest

You decide to hedge your position selling January futures. The resulting payoff diagram of the hedged position resembles:

Question

Suppose you are a farmer that grows soybeans and are approaching the harvest. You won't be able to sell your harvest in the market until January (3 months). You are thus long spot soybeans.

You have the following information:

Spot is 1050

January futures are 1060

January 1060 calls cost 5

January 1060 puts cost 5

Interest rates are 5% simple interest

You decide to hedge your position selling January futures. The resulting payoff diagram of the hedged position resembles:

BlackTom AI · Accepted Answer

The scenario describes a classic use of futures to hedge a physical long position: you own soybeans now (long spot) and you hedge by selling January futures. When you hedge in this manner, you’re aiming to lock in a price by offsetting movements in the spot market with opposite movements in the futures market, so your overall payoff becomes largely insulated from price swings in soybeans.

Option evaluation:
- A flat line: This choice reflects the typical outcome of a perfect or near-perfect hedge using 1:1 futures against a long spot position. If the hedge is correctly implemented (same quantity, same delivery month, and close to neutral basis risk), changes in the spot price are largely offset by opposite changes in the futures position. The result is a payoff that does not depend on future spot price movements, i.e., a constant payoff (a flat line) when plotted against the underlying price at harvest. The remaining variability would come from storage/basis costs or financing, which are fixed or known, so the diagram is effectively flat around that hedged level.

Why other interpretations would be incorrect here (conceptually):
- Any option for a rising or falling line would imply that price movements in the spot market still drive profits or losses after hedging, which contradicts the core purpose of a futures hedge when done properly.
- A volatile or sloped payoff diagram would indicate imperfect hedging, basis risk, or ignoring financing/storage costs. Since this question frames the hedge as selling the January futures against a long spot, the intention is to suppress price-risk exposure, not to amplify it.
- Introducing the option premium (the 5-costs for January 1060 calls/puts) is not part of the hedge when you simply short the futures. Those premiums would matter only if you used options for hedging, not a straight futures hedge, and their presence here does not create a slope in the payoff diagram for the futures hedge.

In summary, a successful long spot with a short futures hedge tends to produce a constant payoff across different possible future spot prices, i.e., a flat payoff diagram, given fixed carry/financing costs and negligible basis change for the chosen hedge.

fin_412_120258_251367 Test 1 in class

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