CME Group Copper futures (HG) are physically deliverable contracts that allow you to hedge volatile Copper prices to mitigate price risk exposures.
Hedging strategies can be used by many different market participants, including but not limited to miners, refiners, smelters, traders, banks and consumers.
In November, a cable manufacturer agrees to buy 50,000 pounds of copper cathodes from a copper smelter for December delivery at the December price.
As the transaction is not at a fixed price, both the smelter and cable manufacturer may be exposed to a change in price between agreeing on the transaction and its future delivery date.
Given the cable manufacturer’s internal practices and approach to risk management, they want to hedge their purchase price against any price changes between the start of November when the physical purchase is agreed until the December price is known.
To offset this price risk exposure, in November the cable manufacturer buys two lots of COMEX Copper December 2016 futures at 2.229.
The spot market price in November is 2.2245. The cable manufacturer would expect to pay 2.2245 x 2 x 25,000 = $111,225 for the physical copper.
As a traditional futures market where positions are margined, P&L is realized daily (daily cash flow) unlike forwards markets where P&L is realized only at maturity.
The copper market price has increased during November and December and the cable manufacturer buys the physical copper at the end of December at 2.495.
Physical P&L = 2.495 x 2 x 25000 = $124,750
To close the hedge position, the cable manufacturer sells two lots COMEX Copper.
December futures contract on December settles at 2.495.
This gives a financial P&L of (2.495 - 2.229) x 2 x 25,000 = $13,300.
This would have given a financial P&L of $13,300 which would offset the loss from the physical P&L of $13,525.
Initial margin costs and trading fees have been excluded in this example.