cash flow hedge

A transaction done to offset risks from the variability of cash flow that would otherwise negatively affect profits. For example, an oil importer projects that the price per barrel of oil will decrease in the future, thus reducing his profits. The importer buys put options for $100 that allows him to sell oil at a price of $50 per barrel next month. On the next month, if the price of oil is $40 per barrel, then the importer gains from the change in price. In this transaction, the put option hedges the risks of price variability.