I can't appreciate the red phrase. Pls see the question in the title. Why can't farmers simply sell their wheat ahead of time to buyers who are capable of storing this wheat, rather than inducing speculators to long the farmers' short positions? Why do farmers need $\color{red}{\text{short hedge}}$?

Zvi Bodie, Alex Kane, Alan J. Marcus. Investments (2018 11 edn). pp. 768-769.

Normal Backwardation

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This theory is associated with the famous British economists John Maynard Keynes and John Hicks. They argued that for most commodities there are natural hedgers who wish to shed risk. For example, wheat farmers desire to shed the risk of uncertain wheat prices. These farmers will take short positions to deliver wheat at a guaranteed price; $\color{red}{\text{they will short hedge. To induce speculators to take the corresponding long positions}}$, the farmers need to offer them an expectation of profit. They will enter the long side of the contract only if the futures price is below the expected spot price of wheat, for an expected profit of $E(P_T) − F_0$. The speculators’ expected profit is the farmers’ expected loss, but farmers are willing to bear this expected loss to avoid the risk of uncertain wheat prices. The theory of normal backwardation thus suggests that the futures price will be bid down to a level below the expected spot price and will rise over the life of the contract until the maturity date, at which point $F_T = P_T$.


"Why can't farmers simply sell their wheat ahead of time to buyers who are capable of storing this wheat..."

"...sell their wheat ahead of time..." is precisely what a futures contract does.

To imply that it is necessarily speculators on the other side is misleading. On a futures exchange, trading is anonymous and identity of counterparty is not known. The counterparty can be a hedge fund taking a long speculative position or a cereal company who intends to take physical delivery.

For the short hedger (farmers in your example), it doesn't matter who is on the other side of the hedge. The futures position eliminates price risk regardless. It's a risk sharing arrangement. The party which has more incentive to shed risk must induce the other side to take the trade. If the short side is more risk averse, this leads to backwardation. Otherwise, contango.

(In particular, empirically expectation hypothesis does not hold for physical commodities. For financial products, no arbitrage would tell you EH holds not under the physical measure but the risk neutral measure.)


The cannot sell the wheat ahead of time since they cannot be sure what the yield on their crop will be. That is, they have no idea whether they can fulfil the contract.

With the futures position, they can close it at a gain or loss that can be covered with cash, and it is independent of their crop yield.


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