Hedging Against Rising Platinum Prices using Platinum Futures

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Contents

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

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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.

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Leverage using Calls, Not Margin Calls

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Understanding Put-Call Parity

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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. ]

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.

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.

Learn More About Platinum Futures & Options Trading

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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

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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. ]

Introduction to Precious Metals Risk Management/Hedging and Ratios

Also available in

How to Manage Precious Metals Price Risk

There are numerous examples of how future and options can be used to manage economic risks inherent in commercial operations and in investment portfolios. This module discusses risk management using COMEX and NYMEX Precious Metals futures.

Market prices respond to changing circumstances. We all know that prices will be different in the future to how they are today, but we do not know how different they will be. At a more basic level, while some people make predictions, no one knows with certainty whether prices will be higher or lower in the future.

One of the most well-known risk management uses of futures contracts is to hedge against uncertain outcomes in the future.

Example

Consider an auto parts manufacturer who has won an order to deliver catalytic converters. Platinum is a significant constituent in the production of these items and the production run will require 32 kg, approximately 995 ounces. of platinum. The firm will take delivery of platinum in two months at the prevailing spot price.

The current spot price is around $867 per ounce and NYMEX April futures are priced at $870 per ounce. To hedge the future payment, the manufacturer needs to buy futures. His requirement is for 995 ounces. Each NYMEX futures contract is for 50 ounces. Buying 20 contracts would provide exposure to 1,000 ounces of metal.

Two months later, the spot price has risen by $90 to $957 per ounce. The firm will take delivery of the metal it needs from a local supplier and does not wish to take delivery through the futures contract. It closes out the futures position in the market at a price of $954 per ounce. The gain made on the futures transaction is $84,000.

Spot Price Position Value Futures Price Position Value
Start $867 995 oz required $862,665 $870 long 20 [email protected] per contract $870,000
End $957 $952,215 $954 $954,000
Result $89,550 additional cost $84,000 hedging gain

This gain offsets the rise in the price of platinum in the physical market, which has resulted in the manufacturer paying $89,550, or over 10%, more for their supply compared to the spot market price at the time they knew they had the exposure. The futures trade therefore provides an effective hedge against the rise in price of the physical supply.

Adding Precious Metals to your Portfolio

Precious metals are widely used in investment portfolios. Futures contracts can be the means of making an investment in precious metals but can also be used as a hedging tool for portfolios consisting of other precious metal assets.

Example

Consider a fund that has an investment in gold. Most of this is held through a holding of gold bars, but around 1% of the fund is held in cash to cover short term cash flow requirements. At the end of May, the spot price of gold is $1,212.1 per ounce. The fund has 20,000 ounces in gold bars and $250,000 in cash, and therefore has an end of month valuation of $24,492,000.

At the end of June, the spot price has risen to $1320.7 per ounce, an increase of 8.96%. Because of the cash balance, the value of the fund has risen to $26,665,000, which is an increase of 8.87%, which is an underperformance versus the benchmark spot price.

This underperformance could be managed with futures. COMEX Gold futures has a 100-ounce contract size. A two lot position therefore represent 200 ounces, or 1% of the physical holding. At the end of May, the August futures settlement price was $1217.5 per ounce, and at the end of June was $1320.6 per ounce. The two lot position has therefore netted a gain of $20,620 over the month. When added to the gain in value of the physical holding, the performance of the fund including the futures position is 8.96%, in line with the benchmark.

Managing Economic Exposure

Futures contracts can be used to overlay physical positions to adjust the economic exposure.

Example

An investor has a holding of 1200 ounces of gold. The current spot price is $1236.5 per ounce, and therefore the value of the holding is $1.48 million. The investor expects that over the next few weeks silver will outperform gold; however she does not wish to close her long term physical position.

The investor modifies her market exposure by selling COMEX Gold futures and buying COMEX Silver futures. The COMEX Gold June futures contract is currently priced at $1231.5 per ounce. The contract size is 100 ounces; therefore the investor needs to sell 12 contracts in order to neutralize her exposure to gold. At the prevailing futures price this transaction has a notional value of $1.477 million. The COMEX Silver May futures contract has a price of $14.756 per ounce, and a contract size of 5,000 ounces. In order to most closely replicate the notional value of the gold futures trade, 20 Silver futures contracts should be purchased.

Over the next few weeks, the prices for both gold and silver increase, but silver has outperformed gold, with the silver spot price rising 16.7% compared the gold spot price rise of 4.7%.

The investor’s physical holding of gold has increased in value by $69,000. However, as planned, this is neutralized by the return on her short position in gold futures. The COMEX Gold June futures price is now $1291.8 per ounce, and this leg of the trade has lost $72,360 in value. The silver futures transaction increased in value to $17.474 per ounce, therefore her silver futures transaction has made a gain of $271,800.

Overall the combined position has made a net gain of $268,440. The investor can close out her futures positions with her physical gold holding being unaffected.

Spot Price Position Value Gold Futures Price Position Value Silver Futures Price Position Value
Start $1236.5 1200 oz Holding $1,483,800 $1231.5 Short 12 contracts @ 100oz per contract $1,477,800 $14.756 Long 20 contracts @ 5000oz per contract $1,475,600
End $1294.0 $1,552,800 $1291.8 $1,552,800 $$17.474 $1,747,400
Result $69,000 gain $72,360 loss $271,800 gain

Summary

COMEX and NYMEX Precious Metals futures contracts can be used to manage risk exposures to precious metals.

Additional Resource

Precious Metals Spot Spreads: Complete Guidebook

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