Sometimes you feel you have to reduce risk with a product and you find there is no futures market available. In this case you might consider the cross hedge, but how are you actually doing this?

Well there are actually two steps necessary

1.  Choosing a proxy commodity

2.  Adapting the product to the proxy commodity

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As a commodity producer your main focus might be production risk, but market risk can minimize your profit where you worked so hard for. When the product is traded on an exchange you can benefit by hedging the commodities. Often producers find this a difficult subject which in fact is rather simple.

When you have the possibility to hedge on an exchange you can consider market risk as just the price fluctuation, but actually market risk existing out of two parts. Price and so called basis. Basis is the relationship between a local cash market price and the futures price (Cash Price – Futures Price = Basis)

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