 By hedging, we mean taking a smaller risk in order to avoid a larger risk. Hedging is of two types, a short hedge and a long hedge. Basically, it is a position of the hedge owner in the market. To understand the mechanics of a short hedge, let's take an example. The example is of a farmer of a wheat, the name of whose is Abelman. In June, Abelman anticipates a harvest of 50,000 bushels of wheat at September end. Now there are two alternatives for him to it. At first, he can write future contracts on the anticipated wheat harvest. The September wheat on the Chicago board, that is a financial trading exchange, is traded at $3.75 per bushel on January 1. And that is the trading rate of the bushel on this particular exchange. The farmer can write 10 bushels on September at the rate of $3.75 per bushel. Now we assume that there is some carrying cost of $0.30 per bushel, so after deducting this carrying cost, the net earning of Abelman would be equal to $2.45 per bushel. The second option with Abelman is that he can harvest without writing any future contracts. In this case, there is a higher risk of price change because there is no person that can know what price in September would be. And second, if there is any rise in the price, Abelman would be in profit and in case of decline in the price, he will suffer some loss accordingly. Now the strategy when envisd Abelman is writing a future contract, it involves a hedge and hedge is a position in the futures market that offsets the risk of person in actual means the person is physically holding some commodity in the market. And in strategy 2, where the Abelman is not writing any hedge, there is an unhedged position because there is no attempt by the Abelman to use future markets to reduce the unforeseen risk. Now hedging seems a quite sensible act, but it might not be adopted by someone due to certain reasons like the person may be unaware to reduce risk through hedging or the person may have a special insight or info regarding the favorable price changes in the market in the days to come. Now in strategy 1, where the farmer is taking a hedge position, it is this strategy is termed as a short hedging or a short hedge as it reducing the risk by selling future contracts. It is very common hedge in the hedge market. It occurs where someone enters either anticipates receiving inventory or he is holding that particular inventory in the market. And in our example, it is Abelman that is harvesting wheat in the market. And that man is taking a short position rather means a short hedge. Now how long hedge position works, let's take another example. On April 1, Moon agrees to sell petrol oil to US government in future and delivery dates and prices have been already set. Now Moon needs to have large quantities of oil on hand to deliver this oil to the US government firm. Now Moon can get oil in one of the two ways. The first way is to buy the oil as the firm needs it. Now this is an unhashed position on April 1 because Moon does not know the prices it will have to pay for the oil in the future. Moon is bearing a little amount of riskiness in this particular situation because already fixed sale prices to the US government has been agreed by Moon. And in this case now is the any increase in the cost the Moon cannot pass on this cost to the US government. The second option with the Moon is to buy some future contracts. In this case the Moon will buying future contracts with the expiration date right in line with the date Moon needs to deliver the oil. It will log in the purchase price to the Moon so Moon will be happily to pay the price in case there is any rise in the price. In this situation the Moon has hedged the risk of fluctuation in the oil prices. Now this strategy too in which the Moon is going for a hedge that hedge is called as a long hedge in which the Moon is buying a future contracts to reduce his risk of any rise in oil prices in the days to come so Moon is taking a long position in the future markets. In long hedge position a firm is committed to a fixed sale price so that that is a reason the firm is taking a long position so we can say that for going into a longer position a prerequisite is that the investor is holding a price fixed for the days to come. Now in that situation Moon is unable to pass on cost to the buyer or does not want to pass on these costs to the buyer. When someone takes a longer hedge this means that the price has been fixed by that person. Now the person is either unable to pass on cost to the buyer or the person does not want to pass on these costs to the buyer in the days to come. Now assume that had the oil were to be sold to a private industry rather than the US government at the current prevailing prices in the future then price rise could easily be passed on to the buyer as it rises in the future. In that particular case Moon might follow the strategy 1 means Moon might not went for the hedge rather it will take an unhessed position.