Hedging Against Falling Platinum Prices using Platinum Futures

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Hedging Against Falling Platinum Prices using Platinum Futures

Platinum producers can hedge against falling platinum price by taking up a position in the platinum futures market.

Platinum producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of platinum that is only ready for sale sometime in the future.

To implement the short hedge, platinum producers sell (short) enough platinum futures contracts in the futures market to cover the quantity of platinum to be produced.

Platinum Futures Short Hedge Example

A platinum mining firm has just entered into a contract to sell 5,000 troy ounces of platinum, to be delivered in 3 months’ time. The sale price is agreed by both parties to be based on the market price of platinum on the day of delivery. At the time of signing the agreement, spot price for platinum is USD 964.00/oz while the price of platinum futures for delivery in 3 months’ time is USD 960.00/oz.

To lock in the selling price at USD 960.00/oz, the platinum mining firm can enter a short position in an appropriate number of NYMEX Platinum futures contracts. With each NYMEX Platinum futures contract covering 50 troy ounces of platinum, the platinum mining firm will be required to short 100 futures contracts.

The effect of putting in place the hedge should guarantee that the platinum mining firm will be able to sell the 5,000 troy ounces of platinum at USD 960.00/oz for a total amount of USD 4,800,000. Let’s see how this is achieved by looking at scenarios in which the price of platinum makes a significant move either upwards or downwards by delivery date.

Scenario #1: Platinum Spot Price Fell by 10% to USD 867.60/oz on Delivery Date

As per the sales contract, the platinum mining firm will have to sell the platinum at only USD 867.60/oz, resulting in a net sales proceeds of USD 4,338,000.

By delivery date, the platinum futures price will have converged with the platinum spot price and will be equal to USD 867.60/oz. As the short futures position was entered at USD 960.00/oz, it will have gained USD 960.00 – USD 867.60 = USD 92.40 per troy ounce. With 100 contracts covering a total of 5000 troy ounces, the total gain from the short futures position is USD 462,000

Together, the gain in the platinum futures market and the amount realised from the sales contract will total USD 462,000 + USD 4,338,000 = USD 4,800,000. This amount is equivalent to selling 5,000 troy ounces of platinum at USD 960.00/oz.

Scenario #2: Platinum Spot Price Rose by 10% to USD 1,060/oz on Delivery Date

With the increase in platinum price to USD 1,060/oz, the platinum producer will be able to sell the 5,000 troy ounces of platinum for a higher net sales proceeds of USD 5,302,000.

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However, as the short futures position was entered at a lower price of USD 960.00/oz, it will have lost USD 1,060 – USD 960.00 = USD 100.40 per troy ounce. With 100 contracts covering a total of 5,000 troy ounces of platinum, the total loss from the short futures position is USD 502,000.

In the end, the higher sales proceeds is offset by the loss in the platinum futures market, resulting in a net proceeds of USD 5,302,000 – USD 502,000 = USD 4,800,000. Again, this is the same amount that would be received by selling 5,000 troy ounces of platinum at USD 960.00/oz.

Risk/Reward Tradeoff

As can be seen from the above examples, the downside of the short hedge is that the platinum seller would have been better off without the hedge if the price of the commodity went up.

An alternative way of hedging against falling platinum prices while still be able to benefit from a rise in platinum price is to buy platinum put options.

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Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Hedging Against Rising Platinum Prices using Platinum Futures

Businesses that need to buy significant quantities of platinum can hedge against rising platinum price by taking up a position in the platinum futures market.

These companies can employ what is known as a long hedge to secure a purchase price for a supply of platinum that they will require sometime in the future.

To implement the long hedge, enough platinum futures are to be purchased to cover the quantity of platinum required by the business operator.

Platinum Futures Long Hedge Example

An automaker will need to procure 5,000 troy ounces of platinum in 3 months’ time. The prevailing spot price for platinum is USD 964.00/oz while the price of platinum futures for delivery in 3 months’ time is USD 960.00/oz. To hedge against a rise in platinum price, the automaker decided to lock in a future purchase price of USD 960.00/oz by taking a long position in an appropriate number of NYMEX Platinum futures contracts. With each NYMEX Platinum futures contract covering 50 troy ounces of platinum, the automaker will be required to go long 100 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that the automaker will be able to purchase the 5,000 troy ounces of platinum at USD 960.00/oz for a total amount of USD 4,800,000. Let’s see how this is achieved by looking at scenarios in which the price of platinum makes a significant move either upwards or downwards by delivery date.

Scenario #1: Platinum Spot Price Rose by 10% to USD 1,060/oz on Delivery Date

With the increase in platinum price to USD 1,060/oz, the automaker will now have to pay USD 5,302,000 for the 5,000 troy ounces of platinum. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the platinum futures price will have converged with the platinum spot price and will be equal to USD 1,060/oz. As the long futures position was entered at a lower price of USD 960.00/oz, it will have gained USD 1,060 – USD 960.00 = USD 100.40 per troy ounce. With 100 contracts covering a total of 5,000 troy ounces of platinum, the total gain from the long futures position is USD 502,000.

In the end, the higher purchase price is offset by the gain in the platinum futures market, resulting in a net payment amount of USD 5,302,000 – USD 502,000 = USD 4,800,000. This amount is equivalent to the amount payable when buying the 5,000 troy ounces of platinum at USD 960.00/oz.

Scenario #2: Platinum Spot Price Fell by 10% to USD 867.60/oz on Delivery Date

With the spot price having fallen to USD 867.60/oz, the automaker will only need to pay USD 4,338,000 for the platinum. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the platinum futures price will have converged with the platinum spot price and will be equal to USD 867.60/oz. As the long futures position was entered at USD 960.00/oz, it will have lost USD 960.00 – USD 867.60 = USD 92.40 per troy ounce. With 100 contracts covering a total of 5,000 troy ounces, the total loss from the long futures position is USD 462,000

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the platinum futures market and the net amount payable will be USD 4,338,000 + USD 462,000 = USD 4,800,000. Once again, this amount is equivalent to buying 5,000 troy ounces of platinum at USD 960.00/oz.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the platinum buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising platinum prices while still be able to benefit from a fall in platinum price is to buy platinum call options.

Learn More About Platinum Futures & Options Trading

You May Also Like

Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Platinum Futures

When people think of platinum, jewelry and the automobile industry are usually the first associations that come to mind. In actuality, however, platinum is found in one-fifth of everything we use in our daily lives. It is no surprise, then, that platinum’s multiuse functionality has earned its increased importance in the futures markets over the past few years. Platinum futures can be used as a hedging tool for both producers and consumers of platinum alike. Platinum futures also offer advantages like central clearing and transparency of price among traders. Due to scarce production, limited suppliers, and its role as an industrial metal, platinum futures prices can exhibit volatility.

Platinum Contract Specifications
Product Symbol PL
Venue CME Globex, CME ClearPort, Open Outcry (New York)
Trading Hours CME Globex: Sun–Fri 5:00pm–4:15pm CT with a 45-minute break each day beginning at 4:15pm
CME ClearPort: Sun–Fri 5:00pm–4:15pm CT with a 45-minute break each day beginning at 4:15pm
Open Outcry: Mon–Fri 7:20am-12:05pm CT
Contract Size 50 troy ounces
Price Quotation U.S. Dollars and Cents per troy ounce
Minimum Fluctuation $0.10 per troy ounce
Termination of Trading Trading terminates on the third last business day of the delivery month.
Listed Contracts Trading is conducted over 15 months beginning with the current month and the next two calendar months before moving into the quarterly cycle of January, April, July, and October..
Settlement Type Physical
Settlement Procedure Daily Platinum Futures Settlement Procedure
Final Platinum Futures Settlement Procedure
Delivery Period Delivery may take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but not later than the last business day of the current delivery month.
Grade and Quality Specifications Platinum delivered under this contract shall be a minimum of 99.95% pure.
Exchange Rules These contracts are listed with, and subject to, the rules and regulations of NYMEX.
Source: CME

Platinum Facts

Platinum is a very rare metal and considered to be more valuable than gold. It is very resistant to both natural elements and electricity. Platinum mines exist across the globe, but its main production is concentrated in South Africa accounting for nearly 80% of the world’s supply. Russia and North America account for the remaining platinum supply. The largest consumer section for platinum is the international jewelry industry followed by auto catalysts. The United States is a heavy importer of platinum, with jewelry and automotive industries dominating market demand.

Last updated May 2020

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