Over-Hedging

Over-Hedging

A hedged position in which the offsetting position is for a greater amount than the underlying position held by the firm entering into the hedge. While hedging ensures price certainty, over-hedging can in effect become partly a hedge and partly a speculative investment and can unduly hurt a firm.

Notes:

The over-hedged position essentially locks in a price for more goods, commodities or securities than is required to protect the position held by the firm.

For example, if a firm entered into a January futures contract to sell 25,000 mm Btu at $6.50/mm Btu but the firm had only an inventory of 15,000 mm Btu that they're trying to hedge, but due to the size of the futures contract the firm now has excess futures contracts that amount to 10,000 mm Btu, this would be a speculative investment.

See also: CBOT, CME, Futures, Futures Contract, Futures Market, Hedge, Speculation