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Sometimes referred to as a long hedge, the buying hedge has to do with buying futures with an eye to safeguarding the investor from the potential for the cost of the investment to increase at some point before the maturity date on the contract arrives. Since the general idea of a futures contract is to secure today and finish paying for the asset at a specified date in the future, using a buying hedge of this type has several advantages for the investor.
One of the most common applications of the buying hedge approach has to do with ensuring a good chance that any cash commodity acquired will produce a return at a later date. When related to futures, this means that the investor can use a buying hedge to secure rights to a commodity at a price that is considered equitable by both parties. At the same time, the investor will be entering into the agreement with a fairly strong sense that the value of the commodity will increase between the time of the initiation of the futures contract and the due date that will conclude the purchase.
The advantage to the buying hedge is that the investor gets control of the asset at a price that is relatively low, but will prove to be below market value when the final payment for the commodity is due. Since the investor paid the lower price, this means that once the terms of the futures contract is fulfilled, it is possible to immediately realize a profit from the investment.
Using a buying hedge is also an excellent way to maximize the use of available resources for investment activity. By deferring full payment until a later date, it is possible to engage in more types of investments and generate additional revenue, all while still basing the activity on the same basic bank of financial assets. For the savvy investor this can create the opportunity to make a significant amount of money before the futures become due, and then make even more money by selling the assets acquired as part of the futures contract at a profit.
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