ABSTRACT
Using futures contracts as hedging vehicles opens up new possibilities: one could close the hedge by reversing out of the futures position and/or the spot position. The added cost of this flexibility is being subject to the daily cash flow implications based on daily settlement. Traditional hedging fails to accomplish its goal in the case, which is to reduce risk relative to a naked spot position. In this case, all hope of reducing risk through traditional hedging is lost because there is simply not enough correlation between the spot price and the futures price to do so. The beauty of spread trading, like that of basis trading, is that the spread basis is generally less volatile than the nearby futures price. A long hedge is a buying hedge, in which futures contracts are bought in conjunction with a short position in the inventory.
