1) Reduce Price Risk
Prices are inherently changing. Rolling and rocking like a freighter on gentle ocean waves, or rising and crashing like a dingy in a hurricane. Price volatility creates risk that the value of your products will decrease between when you paid for inputs and when you sell your outputs, resulting in lower profits or even losses. Hedging is a tool you can use to remedy this. Hedging is defined by Investopedia as “making an investment to reduce the risk of adverse price movements in an asset.” Hedging allows for the reduction or removal of yourself from a price drop by “locking in” a favorable price.
2) Make a Profit
If you know your costs of production then it is easy to calculate your break even and determine what price you need to receive to make a profit. If prices are at or above your break even, and an acceptable profit is available, then you can hedge and lock in those prices. As my grandpa used to say “it’s hard to go bankrupt when you are consistently making a profit.”
3) Plan Ahead
Hedging can be done with old crop you have in storage, new crop that you haven’t even planted yet, and inputs you plan on buying. Hedging isn’t only for protecting against decreasing prices on products you plan on selling. You can also hedge in order to protect against price increases on things you are going to buy . Hedging allows you to lock in a price for your inputs and lock in a price for your outputs, all for stuff that you are going to do next year. You can have a profit locked in for a crop that you haven’t even planted yet.
4) Sleep Better
Hedging takes the guesswork out of knowing if you are going to make a profit, or the extremely unfavorable alternative. Instead of planting a crop and hoping and praying that prices will be at a profitable level when you harvest, you can lock in a profitable price when you plant. Hedging removes you from price volatility and helps you get better sleep at night.