It is the beginning of January, a European coal trader calculates today his selling price for 150,000mt coal from Richards Bay to the Continent which he intends to ship by the end of the first quarter of March. Foreign exchange fluctuations and freight rates are some variables which the dealer is keen to fix today in order to secure enough profit in reference to his selling price. He fears increasing charter rates and therefore wants to take advantage of the current costs of shipment to secure his targeted profit margin.
Today, beginning of January, the dealer buys a March Route 4 (BCI) Richards Bay / Rotterdam FFA expiring by the end of March. the today’s contract price is $ 19.00. The settlement price, used by the end of the period, results from the average of the last published index days in March.
The charter rates have risen and the coal trader has to fix his cargo of 150,000mt coal at $ 22.00 per ton. This represents a difference of $3.00 per ton to the bought FFA, thus is 150,000 x $ 3.00 = $ 450,000.
As the indices refer to the development of the physical charter market the settlement of the FFA (basis risk excluded) is as well $ 22.00 per ton. The coal trader bought for $ 19.00 and receives therefore $ 3.00 per ton from the paper trade. Speaking of an agreed amount of 150,000mt coal his makes a $ 450,000 profit on the paper side.
The result: the physical freight and the paper profit net each other out. The coal trader secures successfully his calculated profit by buying the FFA in January at $ 19.00 per ton.
In the case of a decreasing market the situation is vice versa. The coal trader loses on the paper side, wins however on the physical due to falling freight rates for his ship. The final results remains unchanged – he gains $ 19.00 from his cargo.
It is mid November. A shipowner knows that by the end of the first quarter of the upcoming year one of his Supramax vessels, which is trading spot, will be open in the market. Normally he fixes his ships for three to six months and would like to do same for the second and third Quarter of next year.
As a shipowner he is the seller of freight, therefore he is the seller of the FFA contract as well. He believes the market will decline and therefore wants to secure the current forward rates for the upcoming year on the paper market. He sells a Q2&3 FFA contract per day.
In case the shipowner made a correct forecast (the charter market dropped by the end of the first quarter) the price for Q2&3 (basis risk excluded) is reduced to the same value. By fixing a period charter for his vessel he simultaniously buys back the same FFA cheaper price and secures therefore the difference to his selling price times the period.
Basically he fixes his ship at $ 20.000 per day for six months. In comparison to his FFA Position this means a difference of $5,000 daily, during a period of six months its $ 5,000 x 183 days = $ 915,000.
At the same time his paper position for Q2&3 dropped also to $ 20,000. The owner purchases the FFA at this level back. By buying back his Q2&3 FFA, being $ 5,000 less than he sold last year, he nets his smaller charter rate with an identical gain on the paper position over the 183 days.
In case the charter rates are higher at the moment of the physical fixture, compared to last year, the above situation is to be seen vice versa. The final result remains $ 25,000 are locked in. The shipowner would have the possibility facing an increasing market to close his positions sooner and to accept a reduced loss on the paper side but to fully profiting from the rising rates on the physical market. However you have to keep in mind that a protection via a hedge would be annulated being dependent from the market movements.