Hi all, I came across with the following situation and suddenly feel confused about it:
It says: Assume that a hedge is put in place at time t1 and closed out at t2.
And a hedger who knows that the asset will be sold at t2, and takes a short futures position at t1. The price realized for the asset is S2, and the profit on the futures position is F1 - F2. The effective price that is obtained for the asset with hedging is therefore S2 + F1 - F2.
I was wondering shouldn’t the profit or loss be F1 - S2, and the realized price be F1? Because when the hedger enters into the short futures contracts, he will be obligated to sell the asset at the price of F1, so the realized price is F1.
When he sells it at t2, the actual price for the underlying asset is S2, and he sells it for F1, so the payoff should be F1 - S2, and that should be a loss. I don’t understand what it has something to do with F2?
But at t=2, the future contract is not at expiration (you can see it on the graph), so he’s not selling the asset at that price, he’s closing his future contract position by being long in a future contract at t=2, at price F2. so he makes a profit on his futures transactions of F1-F2 and a profit(loss) on his asset of S2-S1.
