Should Your Company Hedge? Five Questions to Ask Yourself

Companies ask us the same question constantly: we are not large, we have no futures desk — should we hedge at all? The answer is neither yes nor no. Answer the five questions below first. If two or more apply, your company is already carrying a risk that is not priced into anything.

Question 1: Over the past year, did input or product prices move enough to wipe out your annual profit?

Start with a simple calculation. Take a company with RMB 300 million of annual revenue and a 4% net margin — RMB 12 million of profit. If the main input is 60% of cost, that is RMB 180 million. A 10% move in that input's price is a RMB 18 million swing in cost — RMB 6 million more than the entire year's profit.

This is the point most often missed: price volatility can outweigh everything the business can improve on its own. Lifting net margin by one percentage point might take a year of optimising lines, cutting costs and improving yield. One month of input price movement can erase all of it.

If you cannot state that swing as a number, that is the first gap. Without quantification, risk management stays at the level of feeling.

Question 2: Before signing an order, can you calculate its actual profit?

Most traders know this scene: you quote at today's input price and see 6% margin. Three months later at delivery the input is up 9% and the order is a loss. The contract is signed, the selling price is fixed — the cost was never locked.

The structural issue is that selling prices and procurement costs are typically fixed at different points in time. The gap between them is the exposure window. The longer and larger it is, the more hidden risk the company carries.

Whether you can lock profit at the moment of order is the line between trading and betting on the market. Basis trading, pricing mechanisms, and futures or option combinations all do the same thing — they close that time gap.

Question 3: If input prices jump 15% tomorrow, how many options do you actually have?

If the answer is only "negotiate a price increase with customers" and "absorb it ourselves", your toolkit is single-track — and both actions happen after the fact. Worse, in a soft demand market your ability to raise prices is usually very limited.

Mature companies typically hold several levers: building futures length early to lock input cost, using options to cap the price, agreeing basis pricing with suppliers, and adjusting procurement pace and inventory levels. What these share is that they all take effect before the price moves.

Question 4: Are your main competitors already locking costs with derivatives?

This is routinely underestimated. In a competitive industry, if a rival has locked 70% of input cost while you are fully exposed, then in an upcycle they can hold quotes while you must raise prices; in a downcycle they release cost savings while you digest expensive inventory. You end up disadvantaged in both directions.

Hedging is therefore not only defensive. It is also a competitive posture: it denies others the ability to squeeze you with price volatility.

Question 5: If the market moves again next year, can your cash flow take it?

This is the most practical question of all. Risk ultimately settles as cash flow: inventory write-downs, margin calls, stretched receivables. Many companies fail not on the income statement but at a specific moment of cash strain.

Margin funding deserves particular attention. When prices move against you, the futures account requires additional margin. Without reserved funding, the worst outcome is being forced to close at the least favourable price — the hedge not only fails to protect, it becomes a realised loss.

Conclusion: two or more hits means it is time for a structured review

Hedging is not a cure-all. If the main risk comes from weak demand, outdated capacity or receivables, derivatives will not help — they may even mask the real problem. The use case is specific: price is the dominant variable in your profit, and you can identify and bear basis and funding risk.

The real question is never whether to do it, but with what structure, at what size, managed by whom, and how losses will be explained. None of these has a standard answer — they must be designed around your exposure profile, funding capacity and governance maturity. That is why we recommend a diagnostic before buying a single futures contract.

If you are unsure about the first three questions, exposure identification and policy are still blank. That is exactly the part that can be built quickly: an exposure mapping, a policy and one round of team training usually move a company from instinct to evidence in four to eight weeks.