Hedging With Futures Means You Have Two Positions, Not Zero
Quote from chief_editor on May 30, 2026, 3:30 pmA physical commodity position hedged with futures doesn't become a zero-risk position. The trader now has two positions, each with its own risks.
A trader asks: "If I buy 500 tonnes of copper at $9,200 and immediately sell 500 tonnes of LME copper futures at $9,200, I have no risk. I'm flat. Correct?"
The question appears in various forms from traders who are new to physical commodity markets and have been told that futures are used to hedge physical positions. The logic — buy physical, sell futures, net exposure zero — has intuitive appeal. It is also incorrect in ways that produce real financial consequences when the hedge is expected to protect and does not.
The trader who has bought physical copper and sold LME copper futures does not have zero risk. They have two positions: a long physical position and a short futures position. Each position has its own independent risks. The hedge reduces the price direction risk — if copper prices fall, the futures short gains value that offsets the physical loss, in theory. What it does not eliminate is the risk that the two positions diverge — that the physical copper they hold trades at a different relationship to the LME price than it did when the hedge was established.
You Are Now Long Basis and Short Price Direction
When a physical commodity trader buys physical and sells futures as a hedge, they have effectively transformed a directional price bet (long copper) into a basis bet (long physical-versus-futures spread). The directional risk is substantially reduced — assuming the hedge ratio is correct and the pricing period aligns. The basis risk — the risk that the physical premium or discount versus the LME price changes — is now the primary risk.
For copper cathodes, the physical price is typically expressed as LME plus or minus a premium that reflects local supply-demand conditions, the specific grade and location, and the time period of delivery. This premium is not fixed. In tight markets, it rises; in loose markets, it falls. A trader who bought physical at LME plus $50 and sold LME futures expecting to lock in the $50 margin discovers that the margin has changed to $20 by delivery time — not because LME moved, but because the physical premium compressed.
The $30-per-tonne basis move on 500 tonnes is a $15,000 loss on a hedge that was supposed to produce a locked-in profit. The hedge performed exactly as designed — it reduced LME price direction risk — but the basis moved in a way the trader did not model.
Industry estimates suggest that basis volatility in physical copper cathode markets — the variation in the physical-to-LME spread — is large enough to be a material profit driver in base metal physical trading. Traders who understand basis dynamics and who have a basis view alongside their price direction view make different hedging decisions than those who treat a sold futures position as a complete hedge.
The Margin Call Risk on the Futures Position
There is a second structural challenge with the physical-plus-futures hedge: the futures position requires margin. When LME copper rises — which benefits the physical long position — the LME futures short faces losses and requires variation margin calls. The trader must have available cash to meet those margin calls even though the offsetting gain is sitting in the physical inventory, which is not liquid.
A trader who has $2 million of physical copper inventory and $200,000 of available cash, with a 500-tonne LME futures short, faces margin calls when copper rises. The physical gain is real but unrealized — the metal is in the warehouse, not in the bank account. The margin call requires cash now. If copper rises $300 per tonne, the futures position loses $150,000 against the 500-tonne short — a significant call against $200,000 of available cash.
Traders who discover this dynamic while their hedge is open are forced to either close the futures position (losing the hedge) or find emergency cash to fund margin (at cost). The physical-futures hedge requires liquidity management that treats the futures margin requirement as a real-time cash obligation, not as an accounting offset against the physical gain.
A physical commodity position hedged with futures doesn't become a zero-risk position. The trader now has two positions, each with its own risks.
A trader asks: "If I buy 500 tonnes of copper at $9,200 and immediately sell 500 tonnes of LME copper futures at $9,200, I have no risk. I'm flat. Correct?"
The question appears in various forms from traders who are new to physical commodity markets and have been told that futures are used to hedge physical positions. The logic — buy physical, sell futures, net exposure zero — has intuitive appeal. It is also incorrect in ways that produce real financial consequences when the hedge is expected to protect and does not.
The trader who has bought physical copper and sold LME copper futures does not have zero risk. They have two positions: a long physical position and a short futures position. Each position has its own independent risks. The hedge reduces the price direction risk — if copper prices fall, the futures short gains value that offsets the physical loss, in theory. What it does not eliminate is the risk that the two positions diverge — that the physical copper they hold trades at a different relationship to the LME price than it did when the hedge was established.
You Are Now Long Basis and Short Price Direction
When a physical commodity trader buys physical and sells futures as a hedge, they have effectively transformed a directional price bet (long copper) into a basis bet (long physical-versus-futures spread). The directional risk is substantially reduced — assuming the hedge ratio is correct and the pricing period aligns. The basis risk — the risk that the physical premium or discount versus the LME price changes — is now the primary risk.
For copper cathodes, the physical price is typically expressed as LME plus or minus a premium that reflects local supply-demand conditions, the specific grade and location, and the time period of delivery. This premium is not fixed. In tight markets, it rises; in loose markets, it falls. A trader who bought physical at LME plus $50 and sold LME futures expecting to lock in the $50 margin discovers that the margin has changed to $20 by delivery time — not because LME moved, but because the physical premium compressed.
The $30-per-tonne basis move on 500 tonnes is a $15,000 loss on a hedge that was supposed to produce a locked-in profit. The hedge performed exactly as designed — it reduced LME price direction risk — but the basis moved in a way the trader did not model.
Industry estimates suggest that basis volatility in physical copper cathode markets — the variation in the physical-to-LME spread — is large enough to be a material profit driver in base metal physical trading. Traders who understand basis dynamics and who have a basis view alongside their price direction view make different hedging decisions than those who treat a sold futures position as a complete hedge.
The Margin Call Risk on the Futures Position
There is a second structural challenge with the physical-plus-futures hedge: the futures position requires margin. When LME copper rises — which benefits the physical long position — the LME futures short faces losses and requires variation margin calls. The trader must have available cash to meet those margin calls even though the offsetting gain is sitting in the physical inventory, which is not liquid.
A trader who has $2 million of physical copper inventory and $200,000 of available cash, with a 500-tonne LME futures short, faces margin calls when copper rises. The physical gain is real but unrealized — the metal is in the warehouse, not in the bank account. The margin call requires cash now. If copper rises $300 per tonne, the futures position loses $150,000 against the 500-tonne short — a significant call against $200,000 of available cash.
Traders who discover this dynamic while their hedge is open are forced to either close the futures position (losing the hedge) or find emergency cash to fund margin (at cost). The physical-futures hedge requires liquidity management that treats the futures margin requirement as a real-time cash obligation, not as an accounting offset against the physical gain.