Spread trades

According to market sources, freight derivatives are described as the “missing link” between disparate markets in the underlying commodities, creating hedging and arbitrage

Table 6.12 Daily FFA and spot prices of the time-charter route P2A of BPI

Date

FFA price (FJ ($/

Natural logarithm of f, ln(FJ

AF =

ln(F)-ln(FJ

Spot price (SJ (S/day)

Natural logarithm of Sr ln(S') "

AS' =

htfSJ-InfSJ

01 March

43,625

10.683

41,615

10.636

02 March

44,500

10.703

0.020

41,638

10.637

0.001

03 March

44,500

10.703

0.000

41,712

10.639

0.002

04 March

45,250

10.720

0.017

42,244

10.651

0.013

07 March

45,250

10.720

0.000

42,787

10.664

0.013

08 March

45,7 50

10.731

0.011

43,232

10.674

0.010

09 March

46,375

10.745

0.014

43,944

10.691

0.016

10 March

46,375

10.745

0.000

45,016

10.715

0.024

11 March

46,375

10.745

0.000

45,618

10.728

0.013

14 March

46,375

10.745

0.000

45,764

10.731

0.003

15 March

45,500

10.725

-0.019

45,815

10.732

0.001

16 March

45,500

10.725

0.000

45,545

10.726

-0.006

17 March

46,750

10.753

0.027

45,576

10.727

0.001

18 March

46,250

10.742

-0.011

45,757

10.731

0.004

21 March

46,500

10.747

0.005

46,243

10.742

0.011

22 March

45,500

10.725

-0.022

46,688

10.751

0.010

23 March

44,500

10.703

-0.022

46,856

10.755

0.004

24 March

44,500

10.703

0.000

46,631

10.750

-0.005

29 March

44,750

10.709

0.006

46,563

10.749

-0.001

30 March

43,125

10.672

-0.037

46,188

10.740

-0.008

31 March

42,500

10.657

-0.015

45,776

10.732

-0.009

Standard Deviations

0.0158

0.0087

Correlation Coefficient between ASt and AFt, psp

0.3145

Note: Route P2A is the Skaw Passero-Gibraltar to Taiwan-Japan time-charter mute of the BPI.

opportunities. To see how such arbitrage opportunities may arise, consider the following cases. The differential between the Brent and WTI may be used for spread trades; oil markets are linked together by several Europe and North Sea/US East Coast tanker routes. Likewise, Atlantic and Pacific coal markets are linked together by chartered Cape- size vessels. For instance, there may be arbitrage possibilities between CIF (Cost, Insurance, Freight) and FOB (Free On Board) Richards Bay coal prices, as the CIF element is included in the commodity (coal) trade price, while the FOB freight prices are paid separately. Traders can lock in the implied freight element between the two prices and then switch out through an FFA trade.

The differential between the All Publications Index, API 2 CIF (coal delivered into northwest Europe — ARA) and API 4 FOB (coal loading price at Richards Bay, South Africa) swap contracts can be traded against the cost of the C4 (Capesize — Richards Bay to Rotterdam) FFA contract. The fact that coal can be shipped from multiple origins into Rotterdam causes the differential between delivered coal (API 2) versus FOB Richards Bay (API 4) to deviate, at times, from the price of freight on the C4 freight route. A typical trade is where an arbitrageur sells the implied freight differential of the two coal swaps (API 2 minus API 4) and buys the FFA on the C4 route. The inflows of coal from other origins can lower the delivered price in Rotterdam, enabling a trader to gain on the short position in implied freight, while the FFA price remained unchanged. Besides geographical reasons, there are also technical reasons for the existence of arbitrage opportunities; they include: (i) the settlement of the two API contracts and the FFA are based on quotes from different market sources. For instance, settlement of API 2 is based on information from Argus,3 for API 4 from Argus, the IHS Markit (McCloskey Group)4 and the South African Coal Report and for FFA settlement, information comes from the Baltic Exchange; (ii) Capesize refers to vessels hauling 130,000mt to 180,000mt of bulk cargo; (iii) lot sizes differ. For both API 2 and API 4, the lot size is 5,000mt for nearby months. The lot size of the ECC C4 FFA contract is l,000mt lots. These discrepancies create basis risk. Therefore, there is a trend towards an even more integral relationship between the freight and coal businesses, as freight rates may determine a trader’s choice of where to buy coal from.

Consider next a numerical example of a spread strategy. Suppose that a trader believes that during the following months freight rates will increase and wishes to get advantage of it by entering the FFA market. On 10 October, Q1 is trading at $32,000/day, Q2 is trading at $32,850/day and Q3-Q4 is trading at $26,000. As shown in Table 6.13, the trader buys the cheap Q3—Q4 (184 days) contract at $26,000/day and simultaneously sells Q2 (91 days) at S32,850/day. On 30 December he sells Q3-Q4 at $31,000 and buys Q2 at $39,000. The outcomes of these transactions are the following: On the Q3-Q4 position there is a profit of $920,000 [= ($31,000/day — $26,000/day) x 184 days], while on the Q2 position there is a loss of S560,000 [= $32,850 — $39,000) x 91 days]. Combining the two positions results in a net profit of $360,000.

Consider yet another example. Suppose that during May a coal producer has fixed a deal with a shipowner on an un-priced contract for November and that the October FFA settlement of route C4 of the BCI will establish the cost of this vessel s freight. As shown in Table 6.14, today (May) the coal producer buys a Q4 (92 days) at $23,500/day. During July the producer sells freight (55,000mt) at $55/mt for November. On 1 September, he sells (closes out) his Q4 position at $30,000/day and buys a route C4 (60 days) FFA at $35,000/ day. Finally, on 31 October he sells a route C4 FFA at $41,000/day and buys freight, by fixing a vessel, at $64/mt. The outcomes of these transactions are the following: On the Q4 position there is a profit of $598,000 [= (S30,000/day — $23,500/day) x 92 days]. On

Table 6.13 FFA quarters spread speculation strategy

Action

Cash-flows

Profit /Loss

October

Buy Q3-Q4 (184 days): $26,000 Sell: Q2 (91 days): $32,850/day

Cost of Q3-Q4: $4,784,000 (= $26,000 x 184 days) Receipt from Q2: $2,989,350 (= $32,850/day x 91 days)

December

Sell Q3-Q4 (184 days): $31,000 Buy Q2 (91 days): $39,000

Receipt from Q3-Q4: $5,704,000

(= $31,000 x 184 days) Cost from Q2: $3,549,000 (= $39,000 x 91 days)

Profit from Q3-Q4: $920,000 |= ($31,000/day - $26,000/ day) x 184]

Loss from Q2: $560,000 |= ($32,850 - $$39,000) x 91]

Total Profit

4-8360,000

Table 6.14 Spot and FFA spread speculation strategy

Action

Cash-flow

Profit /Loss

May

Buy Q4 (92 days): $23,500/day Buy unpriced freight for November

Cost of Q4: -$2,162,000 (= $23,500/day x 92 days)

J“iy

Sell freight for November: $55/mt

Receipt from freight: 4-$3,025,000 (= 55,000mt x $55/mt)

September

Sell Q4 (92 days): $30,000/day Buy P2A FFA (60 days): $35,000/day

Receipt from Q4: +$2,760,000 (= $30,000/day x 92 days)

Cost of P2A: -$2,100,000 (= $35,000/day x 60 days)

From Q4: +$598,000 [= ($30,000/day - $23,500/ day) x 92]

October

Sell P2A FFA (60 days):

$41,000/day

Buy freight: $64/mt

Receipt from P2A: +$2,460,000 (= $41,000/day x 60 days)

Cost of freight: -$3,520,000 (= 55,000mt x $64/mt)

From FFA P2A: +$360,000 [= ($41,000/day - $35,000/ day) x 60]

Loss from freight: -$495,000 [= ($55/mt - $64/mt) x 55,000mt]

Total Profit

+8463,000

the C4 FFA there is a profit of $360,000 [= ($41,000/day — $35,000/day) x 60]. And on the spot freight position there is a loss of—$495,000 [= ($55/mt — $64/mt) x 55,000mt|. Combining the three positions results in a net profit of $463,000.

 
Source
< Prev   CONTENTS   Source   Next >