ClydeFrog Oklahoma Fan OK Member since Jul 2012 1227 posts Online
hedging question (Posted on 1/31/13 at 2:10 pm)
What's the difference between selling a forward and buying puts? Let's say in the context of a wheat farmer who wants to hedge against potential losses. These two seem similar to me.
foshizzle LSU Fan Member since Mar 2008 25054 posts
re: hedging question (Posted on 1/31/13 at 3:50 pm to ClydeFrog)
Selling a forward means you agree to sell the wheat at a specific price in the future. Unlike the option, there is no question of whether the contract will be exercised. A payoff graph is here:
Buying a put means you have the right (but not the obligation) to sell the wheat at the strike price at some time in the future. The payoff graph is here:
Notice that when you buy the put, you do not have to actually sell at the negotiated price if the market moves against you. Of course, you pay for that privilege.
Another significant difference is that forward contracts tend to be specifically negotiated, whereas options are often standard contracts.
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