Question on What is a Hedge? Jun 22, 2011 We had a reader ask
the following question: “On taxing options, you state that
hedges apply to crops that you raise or feed. However, you say
if you raise wheat but have no livestock an option would not be
a hedge. I am confused. “ The tax definition of hedging is when
a farmer has made a transaction to minimize or eliminate the
risk of price action going against them. For example, a wheat
farmer may purchase a contract on the futures market to sell
short their wheat at $7 per bushel. This contract has locked in
the price that the farmer will receive (subject to basis
adjustments). By entering into this contract, if the price of
wheat goes up a $1 at the elevator, the farmer will get cash of
$8 per bushel but lose $1 on the futures contract for a net of
$7. This is what the IRS calls a hedge. Conversely, if a farmer
only raises livestock and purchases a long contract to buy corn
at $5 per bushel, they have hedged their feed costs by locking
in corn at $5 per bushel (a