Hedging with COMEX Copper futures

  • 7 Apr 2021
  • By Jon Lynch
  • Topics: Metals

Copper prices have always fluctuated, yet it is extremely difficult to forecast when and in which direction those price moves will occur.  One can offset the risk of adverse price fluctuations through hedging.

Risk management tools, such as the COMEX Copper Futures contract, enable copper companies along the entire supply chain to protect profit margins and minimize risk.

How hedging works

Hedging is essentially protection against negative price events.  Just as you protect your home, car or health, hedging guards against having to incur unforeseen or extra costs.  If properly hedged, changes in the underlying prices will be mostly offset by the hedge, thus protecting profit margin and asset value. 

The typical participants of a hedge strategy include the producers of the commodity, and the companies that needs to purchase that commodity sometime in the future. 

Basic Components of Hedging

Underlying Asset

The physical product to be hedged, on which a derivatives product is based.

Derivative

Derivatives are financial instruments whose prices move concurrently with the underlying asset, such as the COMEX Copper Futures contract. (Commodity code: HG)

Derivatives enable copper companies to obtain fixed-price solutions, reduce risk, lock in profits, and protect margins.

Hedging Example:

Scenario:

On July 1st, 2020, a manufacturer of copper wire receives an order that it will not begin producing until January of 2021.  The manufacturer determines it will require approximately 2,500,000 pounds of copper to fulfill this order.

Instead of immediately purchasing all the necessary copper and incurring extra storage costs, the manufacturer decides to hedge the necessary material using COMEX Copper futures (HG).

EXAMPLE:

The COMEX Copper Futures contract (HG) has a contract size of 25,000 pounds.  To hedge 2,500,000 pounds, the manufacturer, therefore, needs to purchase 100 HG futures contracts.

Current price of copper $3.80 per pound

Current January 2021 COMEX Copper futures price $3.83 per pound

On July 1st, 2020, the manufacturer buys 100 January 2021 COMEX HG futures contracts (6 months forward) at $3.83 per pound.

On January 1st, 2021, the manufacturer buys 2.5 million pounds of copper at $4.20 per pound (prevailing price at the time) and simultaneously sells 100 January 2021 COMEX Copper Futures contracts at $4.23 per pound.

In this example, the underlying price of copper has risen $0.40 per pound. Without hedging, the increase in the cost of purchasing the necessary copper is as follows:

2,500,000 X $0.40 =$1,000,000

This increase has been successfully offset by the purchase of COMEX Copper Futures as follows:

100 (contracts) X 25,000 (pounds) X $0.40 = $1,000,000

Profit margin 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 will net the same result.

Contract specifications

Product

Copper Futures Contract

Commodity Code

HG

Contract Size

25,000 pounds

Price Quotation

U.S. dollars and cents per pound

Minimum Tick Size

$0.0005 per pound-$12.50 per lot

Contract Listings

Monthly contracts listed for 24 consecutive months and any March, May, July, September, and December in the nearest 63 months

Trading Hours

6:00 p.m.-5:00 p.m. New York time. Sunday-Friday

Termination of Trading

Third last business day of the contract month

Settlement Type

Deliverable

About CME Group

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