Long and short of futures and forward contracts
On the other hand, the short may take the derivatives position because he has a prior long position in the underlying asset. That is, he owns the asset and is concerned about a perceived price decline. Such a party can lock in a sale price by going short in such contracts. By the time contract expiration approaches, the price of the underlying asset would have either increased or decreased. If it were to have increased, the party that has gone long would be perceived as wise and sound.
On the contrary, if the underlying asset were to have declined in value, the party with a short futures position would have credit bestowed on him for his ability to read the market accurately. In practice, only one of them will be right ex-post and, thus, while one will be complimented for his foresight, the other will be castigated for his foolishness. Such criticism is, however, unfair. For, hedgers use such contracts to mitigate their exposure to price uncertainty and not because they are convinced at the outset that their view on the market will be vindicated subsequently.
Hindsight, as someone said, is a ‘perfect science’. Hedgers are not prescient and, hence, there is every possibility that in their quest to mitigate risk, they end up looking foolish to
Be the first to comment.
