Physical holder of metals needs assistance in reducing risk to market turmoil...

Discussion in 'Risk Management' started by MetalsTrader, Jan 11, 2009.

  1. Hi Elitetraders,

    I am the owner of a small family business that buys and sells surplus commodities, specifically copper and aluminum.

    Until recently, we never had the need to use hedging to protect ourselves from market fluctuations. We weren't large enough and we would be able to move our material fast enough to limit our exposure.

    Boy have things changed. I was fortunate enough to get a queasy feeling about a month and half before this economic tsunami hit us all and unloaded most of our material. If I hadn't we'd be out of business and sunk right now.

    I can't move forward with so much on the line and rely on hunches and feelings any more. I need a way to lock in our gains and reduce our risk to the markets.

    My problem is I don't have the first idea about how to do this. I've been reading EliteTrader for a year now and it's clear this is THE place for professional traders and investors. I hope you won't mind giving a novice a helping hand.

    We buy physical metal everyday; Usually in quantities of 1000-5000 lbs. at a time. We were moving our stock every few months but with market conditions the way they are now, we don't want to hold anything longer than a month. Over the month as we buy, we'll accumulate several hundred thousand dollars worth of inventory that is at risk until we make a sale and have a contract. We only sell to big players. We make a verbal agreement over the phone and then they hedge their purchase of our material while we're on the phone so they're covered. We have 30 days to fulfill our contract with them and deliver our product.
    The prices in our industry are based upon 3-5 month futures prices depending on the volatility of the market.

    Our business is cut-throat and I go up against some very big players. I need to be able to utilize the same tools and techniques as the big boys to protect our investment and to be able to offer better prices to my suppliers to compete. To offer better prices means my margins thin out even more and I'm even more at risk to market calamities like we just witnessed.

    Will you please offer some advice and techniques to help me reduce my risk to these dangerous markets and help a little guy compete with the mega-corporations?

    Thanks for your time and your help.
  2. jem


    1. are the current futures products good hedging vehicles. Do the contract sizes and specs substitute for yours?

    2. If so then you can just make sure you work with a broker who knows when and how things get delivered.

    3. I would also check with the truly large players to see if they will create options or some other product for you. Make sure you have really a good lawyers who understands the transaction go over the contract with you. (unless you are pretty big - you can bet that the counter party may try to screw you.... You need leverage against them unless you are one of them.)

    4. Understand your counter party risk.

    5. If there are no third parties already doing this... start you own business and be your own bookie.
  3. If you are mainly trading in copper and aluminum then establish a fair price depends on a few factors but the simple answer to your heding needs are to use

    LME Futures. There are other ways to hedge but this is probably the best and most efficient way for you as you will probably have issues getting the proper credit lines using OTC mechanisms......
  4. Euler


    COMEX also has both copper and aluminum contracts ( Have you considered these? I think they offer smaller units than does the LME, and it may be a bit easier to trade on, generally -- LME's rules and trading sessions are byzantine by comparison, in my humble opinion. But LME may be more liquid. (LME is based in London, COMEX is a NYMEX unit which is of course US, but I think LME has US physical delivery points -- not really sure, though -- check these out yourself as delivery isn't something traders run into often -- unless they make a huge mistake! Of course, you don't have to take/make delivery unless you hold the contract to expiration.)

    You'll need to look at the contract sizes and what's offered. Beware thinly traded contracts that have high bid/ask spreads, although it doesn't seem like you'll be hedging too far out into the future so this may not be an issue.

    Once nice thing about these exchange-traded contracts is that there's "almost no" counterparty risk, as opposed to OTC stuff where the counterparty (whoever you're trading with) may default if they run into financial problems of their own.

    Also, you may be able to talk to someone at COMEX and/or LME directly. As a commercial hedger, they may be willing to talk to you :D
  5. Aluminum contracts aren't liquid as copper. Depend on your company size; you should look at many sources for your inventory. Recently I had conversations with friend who were complaining about metal market (steel). If you can, look out for Asian smelters.

    Best thing to do is always keep contacts with your customers and improve customers services.
  6. MetalsTrader

    Take a look at this site.

    Scroll down to the contract specs on this page (not the E link it is showing you).

    High Grade Copper Futures and Copper Options
    Contract Specifications
    Trading Unit

    Copper Future: 25,000 pounds

    Copper Options: one COMEX Division high-grade copper futures contract

    Trading Hours

    Copper Futures and Options: 8:10 A.M. to 2:00 P.M. for the open outcry session.

    Trading Months

    Copper Futures: Trading is conducted for delivery during the current calendar month and the next 23 consecutive calendar months.

    Copper Options: Copper options are offered for trading in each of the following contract months: March, May, July, September, and December up to one year to expiration. Serial months are also listed so there are always three consecutive nearby months traded. Twenty-four-month copper options are listed when July and December become the 24th month. The options are American-style and can be exercised at any time up to expiration.

    Price Quotation

    Copper Futures and Options: cents per pound

    Minimum Price Fluctuation

    Copper Futures and Options: Price changes are registered in multiples of five one hundredths of one cent ($0.0005, or $0.05) per pound, equal to $12.50 per contract. A fluctuation of $0.01 is equal to $250 per contract.

    Maximum Daily Price Fluctuation

    Copper Futures: Initial price limit, based upon the preceding day's settlement price, is $0.20 per pound. Two minutes after the two most active months trade at the limit, trading in all months of futures and options will cease for a 15-minute period. Trading will also cease if either of the two active months is bid at the upper limit or offered at the lower limit for two minutes without trading.

    Good Luck

  7. MetalsTrader

    Hope this helps some.

  8. Daily Chart

    If you want something different, more detaill, etc. in the way of the charts or hedging questions (I am much more familiar with hedging grains but the concepts/strategies are pretty much the same), just let me know. Glad to try to help.

  9. as i mentioned before....LME futures is the hedgers market of choice for base metals...MetalsTrader already stated he wants to hedge like the big boys.

    THe only advantage one has hedging comex copper versus LME is that LME one cannot realize locked postions on forward trades. where in comex you can realize positions immediatley upon closeout. COnsidering that he is looking to only hold one month or so, CMX might be suitable...but hedging is not as simple as just selling forward bc one has to pay attention to the spread valuations and his captial structure as you have to manage mark to market losses and have the cash collateral if the spread blows out against you before you intend to make delivery....

    COMEX ALUMINUM Is a waste of time as no one trades has next to NO liquidity....
  10. Aluminum Chart

    #10     Jan 12, 2009