Comment by potato3732842
8 hours ago
Man, it's hilarious how you managed to go full circle around the point while missing it.
If the airline wants to ensure future supply at a given prices they can simply buy futures settled in actual product.
Hedging against future volatility by agreeing on a deal "now" is the entire point. Sure, sometimes you lose when there's a price drop but the other guy won. At the end of the day everyone benefits from smoothing out the volatility.
Buying and selling cash settled futures is just how small time buyers and sellers access the market since they can't take delivery of entire train loads of goods but still need to hedge.
Finance professionals trading them around to wring out an extra percent here and there it beside the point.
Hedging can’t be the only point, which is something we have known since the ancient Babylonians invented futures.
For every person who is trying to hedge future volatility, there has to be a person on the other side of that contract who is speculating on the possibility that the hedge guy is more frightened that they should be.
You need hedgers and speculators to have a two-way market, and in markets where you have predominantly hedgers they get completely fleeced by the few speculators brave/dumb enough to take the other side of their trades. This is because many markets are structurally unbalanced such that the people who need to hedge long (producers) and people who need to hedge short (consumers) operate on different timeframes etc. So if I’m a farmer growing some crop I might want to sell the 1yr future, but the guy trying to hedge the price for purchase (wholesale grocer or whatever) will be hedging the front future like 1m out. So someone has to carry the risk in the forward curve between 1m and 1 year or noone gets the hedge they need and the market doesn’t work.
Quite aside from that, there are all sorts of things which are cash-settled because you literally can’t do a physical settlement but people need to hedge (yes and speculate) anyway. Take an index future on an equity index. How are you going to physically settle a future on the SPX or (god forbid) the Russell? The liquidity consequences would be devastating to markets.
That's just not the case though.
Buyers and sellers both want to hedge and they're both happy to give up some potential upside of getting one over on the other guy in exchange for stability.
As you mentioned, timeframes and volumes often don't match up perfectly. So enter the speculators. They provide a lot of the liquidity. And they get paid for it. Like they make a 1yr bet and 12 1mo counter bets and do that enough that the wins and losses smooth out and they make a few pennies on the dollar.
The futures market is basically a cyclone of financialization whipping around an eye of "actual business doing actual things" that needs to smooth out volatility (because you can't make a huge investment in a volatile market or you might get screwed into not being able to make payroll some quarter even though what you're up to is solvent any given year).
You can apply the same model to financial goods (and you often want to because the solvency of all sorts of banking activities is predicated on market conditions the same way that industrial activity is dependent upon commodity prices and you can't have good stuff going tits up because of a bad quarter)
But at the end of the day you need some core of participants who at the limit are willing to pay to limit/cap/reduce risk and volatility otherwise there's no market because the whole market is bets and counter bets about how that core activity will turn out.
At the end of the day there is a legitimate business need to hedge against future uncertainty. Everything else in the futures market derives from this, though sometimes the paths are nonsensical.
No, this is a common misconception. If hedging was the point, futures markets would show more evidence of risk aversion than they do. Again, I recommend that Williams' book if you're curious!