To hedge future cattle prices using futures, the Crabtrees would initially:

To hedge future cattle prices using futures, the Crabtrees would initially:

• A. Sell futures contracts, expecting to buy them back when the cattle are sold
• B. Buy futures contracts, expecting to sell them later
• C. Buy options on futures, expiring next month
• D. Do nothing and wait for price changes

Answer: (A)

When you plan to sell cattle in the future, you hedge by taking a short position in futures now to lock in a selling price. By selling futures contracts, the Crabtrees establish a price today for cattle they haven’t sold yet. If cash prices drop by the time they actually sell, the gain on the short futures position offsets the lower sale price, helping to stabilize revenue. If prices rise, they’ll miss some upside because the futures are locked in at the lower price, but the main goal is reducing the risk of a price decline. Buying futures would hedge a future purchase or input cost, not a future sale. Buying options on futures is another hedging tool with upfront costs and different risk-reward characteristics. Doing nothing leaves them exposed to price swings in the cattle market.

When you plan to sell cattle in the future, you hedge by taking a short position in futures now to lock in a selling price. By selling futures contracts, the Crabtrees establish a price today for cattle they haven’t sold yet. If cash prices drop by the time they actually sell, the gain on the short futures position offsets the lower sale price, helping to stabilize revenue. If prices rise, they’ll miss some upside because the futures are locked in at the lower price, but the main goal is reducing the risk of a price decline.

Buying futures would hedge a future purchase or input cost, not a future sale. Buying options on futures is another hedging tool with upfront costs and different risk-reward characteristics. Doing nothing leaves them exposed to price swings in the cattle market.