Client:
A metals merchant whose business flow involves purchasing and then reselling aluminum.
Challenge:
Hedging aluminum already purchased as demand declines, and buyers dwindle.
Solution:
Use COMEX Aluminum futures (ALI) to hedge aluminum sales.
Overview
A commodities merchant, who transacts aluminum globally, entered 2022 with the prospect of increased demand, and with that, the potential for decreased availability of reasonably priced metal. Historically, transactions would involve finding an interested buyer and then searching for and securing metal that would fulfill that buyer’s needs.
Since forecasted demand was on the rise, the metals merchant made the decision to commit to purchasing 5,000 metric tons of aluminum every month from one of their suppliers, in advance of securing a buyer, at the prevailing COMEX Aluminum futures price.
As the merchant expected, locating buyers for the aluminum for which there was a previous purchase commitment, was not problematic to begin the year. However, by the end of the first quarter, global inflation figures began to rise steeply and demand decreased dramatically. With that, buyers became increasingly difficult to find.
Faced with an environment of low demand and decreasing prices but having contracted to purchase aluminum on a monthly basis from a consistent source, the merchant decides to hedge the purchases and protect the investment until market dynamics become more favorable.
Approach
In December 2021, the merchant agreed to purchase 5,000 metric tons of aluminum per month throughout the entirety of 2022 at the prevailing COMEX Aluminum futures price on the day of delivery. They were able to secure buyers of that metal through March 2022, but beyond the first quarter, was unable to secure any buyers.
COMEX Aluminum futures allow physical market participants the ability to protect their initial investment and potential profit margin while minimizing the risk associated with adverse price movements.
On the day of delivery in April 2022, the merchant receives 5,000 metric tons of aluminum at the prevailing COMEX Aluminum futures price. At 25 metric tons, the merchant needs to sell 200 COMEX Aluminum futures and makes the decision to sell in the active contract month of June-22 at $3,515.25 per metric ton.
As the merchant prefers to keep their position in the active contract, they roll that position forward each month (buying in the position’s contract month and selling the forward contract month), before the active contract changes, keeping the futures position in the most active contract month.
Active Contract Schedule
On and between these dates … |
…the active/lead contract month is… |
|---|---|
Jan 3-Jan 14 |
Mar-22 |
Jan 18-Feb 14 |
Apr-22 |
Feb 15-Mar 14 |
May-22 |
Mar 15-Apr 14 |
Jun-22 |
Apr 18-May 13 |
Jul-22 |
May 16-June 14 |
Aug-22 |
June 15-July 14 |
Sep-22 |
July 15-Aug 12 |
Oct-22 |
Aug 15-Sept 14 |
Nov-22 |
Sept 15-Oct 14 |
Dec-22 |
Oct 17-Nov 14 |
Jan-23 |
Nov 15-Dec 14 |
Feb-23 |
Dec 15-Jan 13 '23 |
Mar-23 |
Jan 16 ’23-Feb 14 ’23 |
Apr-23 |
Feb 15 ’23-Mar 14 ‘23 |
May-23 |
Mar 15 ’23-Apr 14 ‘23 |
Jun-23 |
Apr 17 ’23-May 12 ‘23 |
Jul-23 |
May 15 ’23-Jun 14 ‘23 |
Aug-23 |
Jun 15 ’23-Jul 14 ‘23 |
Sept-23 |
Jul 17 ’23-Aug 14 ‘23 |
Oct-23 |
Aug 15 ’23-Sep 14 ‘23 |
Nov-23 |
Sep 15 ’23-Oct 13 ‘23 |
Dec-23 |
Oct 16 ’23-Nov 14 ‘23 |
Jan-24 |
The merchant anticipates, in times of low demand, that forward prices could continue to be priced higher than nearby prices and wants to take advantage of the contango.
When the market is in a contango (nearby prices are at a discount to forward prices) a short position holder can benefit from rolling positions forward by earning money to do so. When the market is in a backwardation (nearby prices are at a premium to forward prices) a short position holder will pay to roll positions, which adds a cost to managing positions.
In the absence of physical buyers, the merchant continues to receive 5,000 metric tons of aluminum each month, and simultaneously sells the equivalent amount of COMEX Aluminum futures while continuing to roll their position into the active contract month.
By September 2022, the merchant has accumulated a short position of 1,200 COMEX Aluminum futures now positioned in the November 2022 futures contract.
Results
In September, the merchant was able to secure a buyer for all the aluminum they had accumulated, which amounted to 30,000 metric tons, for immediate delivery, at the prevailing COMEX Aluminum futures price. At that point the merchant was able to remove the futures hedge, and subsequently buy 1,200 COMEX Aluminum futures for contract month Nov-22 at a price of $2,304.25.
Despite the price of aluminum decreasing by over $1,200 per metric ton between the initial delivery to the merchant and the sale to the client, the merchant was able to protect the value of the metal purchased by selling an equivalent number of futures contracts and capturing the decrease in price.
Had the price of aluminum increased over that time, the merchant would have sold the accumulated metal at a higher price, which should have mostly offset the loss of the futures position.
Regardless of the price direction, the risk of adverse price movements is covered with a hedge using the COMEX Aluminum futures contract.
Profit margin and value of the physical material is protected.
It is important to note that by hedging, a company is trying to mitigate risk, not make additional profit through speculation. Therefore, if properly hedged, adverse and favorable price fluctuations can net the same result.
**The aforementioned hedge example and result does not take into account any charges associated with storage, brokerage, exchange fees or the net cost of rolling positions through the use of spreads.
This material is directed only at, persons who are: (i) investment professionals (as that term is defined in article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (“FPO”)), (ii) high net worth companies (as that term is defined in article 49 of the FPO) or (iii) any other persons to whom it may lawfully be communicated. Accordingly, persons who (i) do not have professional experience in matters relating to investments or (ii) are not high net worth companies, should not act or rely on this material. The financial instruments and / or services detailed in this material will only be available to high net worth companies or investment professionals (as defined above). If you are not a high net worth company or investment professional (as defined above) you cannot invest directly and are unable to gain access to the relevant financial instruments. CME GROUP DOES NOT REPRESENT THAT ANY MATERIAL OR INFORMATION CONTAINED HEREIN IS APPROPRIATE FOR USE OR PERMITTED IN ANY JURISDICTION OR COUNTRY WHERE SUCH USE OR DISTRIBUTION WOULD BE CONTRARY TO ANY APPLICABLE LAW OR REGULATION.
