Lead Hedging Basics

Commodity Hedging | 10 min Read

Updated on: 23 rd June 2021

Best Hedging Strategy For Importers, import port

For the uninitiated, when you agree to buy or sell a commodity and the prices are not fixed, you take a so-called ‘price risk’. Say, in June, a battery manufacturer agreed to buy one tonne of refined lead from a lead smelter for August delivery at August price. Since he doesn’t know the price after three months, he is taking a price risk (also a currency risk if he is importing it and paying a different currency). Simply, as the transaction is not at a fixed price, both the smelter and battery manufacturer may be exposed to a change in price between the date of agreeing on the transaction and its future delivery date. Here hedging comes into the picture – Hedging is a technique to ensure your position in the market is not affected by any adverse movements. We mainly hedge using a futures or options contract.

Hedging using Futures:
Sticking to the above scenario, the battery manufacturer is scared that prices might go up in the future. He wants to lock in the spot price that is $2138.50. He could enter into (buy) a ‘3-month futures contract’. This essentially means that he has to buy Leads from the seller after 3 months at the futures price. As shown in the chart below, 3 months’ futures are trading at $2138.50.

To offset this price risk exposure, in June the battery manufacturer buys one lot of LME Lead August futures at $2138.50.
After 3 months:
Let’s assume that the lead market price has increased after 3 months and the battery manufacturer buys the physical lead at the end of August at $2170.
Cash outflow: $2170 (P/L: Loss of $(2138.5-2170) = $31.5)
To close the hedge position, the battery manufacturer sells one lot of LME Lead. (Since futures and spot prices move together, we will assume that August Futures is trading at $2175).
Cash Inflow: $(2170-2138.5) = $31.5 (This is also the P/L of Futures transaction)

Hence the profit from the futures transaction would offset the loss of physical P/L.

Spot Price2138.52170
Physical Position2138.52170(31.5)
Futures Price2138.52170
Futures Position2138.5217031.5
Net P/L0


  1.  The main distinction between a Forward and a Futures contract is: Futures is a standardized contract (both in terms of lot size and date of settlement), it is exchange-traded, unlike a Forwards contract which is not standardized. In futures (unlike forwards), one has to pay a margin upfront to enter into the contract- P&L is realized daily (daily cash flow) unlike forwards markets where P&L is realized only at maturity.
  2. Initial margin costs and trading fees have been excluded in this example.

To get regular updates on USDINR View or to setup a 121 discussion Register Here. Some of India’s largest companies use our USDINR views. You can also Email us for further questions and clarifications.

Sign up for Complimentary Access to Webinars, Trainings and Reports