Hedging with COMEX Copper futures

  • 23 Oct 2020
  • 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 need to purchase the 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:

For example, a manufacturer of copper wire receives an order that it will not begin producing until six months from now. 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. Therefore, in order to hedge 2,500,000 pounds, the manufacturer needs to purchase 100 HG futures contracts.

Current price of copper: $2.35 per pound

Current COMEX Copper futures contract price (six months forward): $2.38 per pound

The manufacturer buys 100 COMEX HG futures contracts (six months forward) at $2.38 per pound.

Six months in the future, the manufacturer buys 2.5 million pounds of copper at $2.75 per pound (prevailing price at the time) and simultaneously sells the 100 COMEX Copper futures contracts at $2.78 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 $1 million price 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 US dollars and cents per pound
Minimum tick size $0.0005 per pound-$12.50 per lot
Contract listings 60 Consecutive Months
Trading hours 6:00 p.m.-5:00 p.m. ET (New York time), Sunday-Friday
Termination of trading Third last business day of the contract month
Settlement type Deliverable

About CME Group

As the world's leading and most diverse derivatives marketplace, CME Group is where the world comes to manage risk. Comprised of four exchanges - CME, CBOT, NYMEX and COMEX - we offer the widest range of global benchmark products across all major asset classes, helping businesses everywhere mitigate the myriad of risks they face in today's uncertain global economy.

Follow us for global economic and financial news.

CME Group on Twitter

CME Group on Facebook

CME Group on LinkedIn