Short Hedge
A short hedge sells futures contracts today to lock in a future selling price. It suits anyone with long cash exposure, such as a commodity producer, an exporter holding foreign currency receivables, or a fund manager planning to liquidate equity. If the spot price falls, the gain on the short futures offsets the loss in the cash market. The effective price received equals , where is the futures price at hedge inception and is the basis at the close date.
Why it matters
A grain farmer owns wheat that will only be sold at harvest. The risk is that wheat prices fall before then. Selling wheat futures today fixes the receivable at . If wheat drops by $20 per tonne, the futures short gains roughly $20 per tonne and the two cancel. The price lock is not exact because basis at close is uncertain, but residual risk is far smaller than outright exposure. The hedger gives up upside as the cost of removing downside.
Formulas
Worked examples
An Australian wheat grower expects to harvest 5,000 tonnes in November. In August she sells 100 ASX Eastern Wheat futures (50 tonnes each) at A$330 per tonne. At delivery in November the spot price is A$300 and the futures settle at A$303.
Spot revenue A$1,500,000. Futures gain per tonne A$27, so total futures gain A$135,000. Total received A$1,635,000, or A$327 per tonne. This equals A$327, which is close to but not exactly the locked-in A$330 because of the realised basis .
An oil producer shorts 1,000 WTI crude futures at US$80 per barrel to hedge October output. By delivery, spot crude has fallen to US$72 and futures to US$72.50.
Loss on physical US$8 per barrel. Gain on futures US$7.50 per barrel. Net price received US$79.50, equal to US$79.50. Basis weakened by $0.50, so the hedger underperforms the locked rate by that amount.
Common mistakes
- ✗A short hedge guarantees you the futures price . It only guarantees you . The realised basis at close is unknown when the hedge is set, so basis risk remains. If you hold to delivery and the futures underlying matches your physical, basis converges to zero and the lock becomes nearly exact.
- ✗A short hedger profits when prices fall. The futures leg profits, but the physical position loses an offsetting amount. The whole point is that the net position is approximately flat. Treating the futures gain as profit is a confusion of cash flow with economic outcome.
- ✗Short hedges remove the need for inventory management. Hedging price risk does not hedge storage costs, deterioration, or counterparty risk on the physical buyer. A producer still bears all operating risks of the underlying business.
Revision bullets
- •Sell futures today, lift them at the close date
- •Suits anyone holding or producing the underlying asset
- •Effective price received
- •Removes price risk but leaves basis risk
- •Gives up upside in exchange for downside protection
- •Hedge effectiveness highest when held to delivery
Quick check
A short hedge is most appropriate for which of the following participants?
An oil producer sells crude futures at US$80 per barrel. At delivery, spot is US$74 and futures are US$75. The effective price received per barrel is closest to:
Connected topics
In learning paths
Sources
- Hull, John C. Options, Futures, and Other Derivatives. 11th ed. Pearson, 2022. ISBN 978-0-13-693997-9.Section 3.1 introduces the short hedge with the textbook oil-producer example. Section 3.4 derives the effective price expression.
- CME Group. How to Hedge Grain Risk. CME Education Centre, accessed 2026.Walks through a producer short hedge in grain futures and explains how basis changes affect realised price.
- Australian Securities Exchange. ASX 24 Contract Specifications. ASX, version 11, December 2025.Reference for ASX Eastern Wheat and Western Wheat futures contract sizes used by Australian producers.
- Ederington, Louis H. The Hedging Performance of the New Futures Markets. Journal of Finance, Vol. 34, No. 1, March 1979, pp. 157-170.Quantifies how much variance a short hedge removes and shows that effectiveness depends on the spot-futures correlation.