Stone
he last few years have witnessed a rapid expansion in the spectrum of option T and futures instruments available to commercial hedgers. Futures markets in financial instruments and foreign currency, introduced in the early 1970s, now account for a major share of the volume. Trading in stock options has multiplied and moved from over-the-counter markets to active organized exchanges. And by the time this piece is published, organized options markets in financial instruments and several other commodities may have begun trading.
The authors believe that hedging in futures and options can be of real value to a commercial enterprise. We are also aware, however, that speculation in commodity contracts presents considerable risks and that it is not always easy for an operating executive or investment manager to tell the difference. This article is intended to provide a framework for distinguishing a true hedging position in commodities from a speculative position, and to describe the menu of possible futures instruments available to the commercial enterprise.
The exposition which follows is intentionally much simplified. It would take more than the space allotted to develop a complete hedging strategy for any realworld business. Rather than attempt to do this, we have drawn our illustrations to fit idealized businesses. We have also ignored any consideration of how commodity contract prices are set, making only the usual assumption that the contract markets are competitive. Our only goals are to provide a framework for understanding the mechanism of a commodity hedge, and to identify a variety of speculative traps which look appealingly similar to hedges. James F. Gammill, Jr. is currently a doctoral candidate in finance at the Sloan School of Management of the Massachusetts Institute of Technology. He served on the Chairman's staff at the CFTC during 1980 and 1981. James M . Stone is a commissioner and former chairman of the Commodity Futures Trading Commission in Washington, D.C. Dr. Stone received both his B.A. and Ph. D. in economics from Harvard University where he then taught as a lecturer on Economics.