Hedging with Jorge #Episode29: Understanding Borrowing & Lending

So far, we’ve covered borrowing and are now getting into lending. Remember this simple rule: you’re lending when you sell the nearby contract and buy the forward one. And when you buy the nearby and sell the forward, that’s borrowing.

Example of Lending

Let’s look at an example. Suppose I’m long in March, but I need to be long in April. To close my March position, I do the opposite transaction—I sell March and buy April. That’s lending. Now, let’s see what happens in different market conditions.

Lending in Contango vs. Backwardation

In a contango market, forward prices are higher than nearby prices. So when you lend, your purchase price is higher, meaning you lose money. But in backwardation—like aluminum is right now—the forward price is lower, so lending makes you money because you’re buying at a cheaper price.

Another Lending Example

Now, let’s say I’m short in April but need to be short in March. To roll my position, I sell in March and buy in April. Again, that’s lending. And just like before, if we’re in contango, lending results in a loss. But in backwardation, it’s profitable.