Back-pricings
How Back-Pricings Work:
Imagine a trader buys 500MT of refined aluminum with the following QP:
Average M or M+1, declarable by the last business day of M.
By declaration day, the full average price of M is known. Suppose:
Average M = $2,550/mt
Market price on the last business day = $2,650/mt
The trader can sell futures at market and declare the M average, securing a $100/mt profit from their futures short against the physical purchase price. Alternatively, if the market price on the last day of M is lower than the M average, the trader can declare M+1 and hedge accordingly, with zero risk to this strategy.
Trading the Optionality:
A trader doesn’t have to wait until the last day to act. If, halfway through M, the market is trading $50/mt above the elapsed average ($2,600 vs. $2,550), they can sell 10 lots at market (half the contract tonnage) and lock in a $50/MT gain on elapsed tonnage. They can continue selling futures for the remaining tonnage whenever the market rises above the average, compounding profits.
What If the Market Drops?
If the trader sold 10 lots at $2,600 but the market falls to $2,500, they could simply buy back those futures. Instead of making $50/MT vs the running average of M, they now profit $100/MT on a speculative position and they are square futures. If the market never recovers, they declare M+1 and hedge over that average.
Why This Matters:
Back-pricing provides built-in flexibility for traders, allowing them to:
🔹 Trade in and out of positions throughout the month
🔹 Lock in profits at multiple points
🔹 Mitigate risks by hedging over alternative QP option(s) if needed
This is a very simple example of a back-pricing. They can get far more complex (and profitable) depending on the specifics of the trade. To fully understand back-pricings, spread options, and other powerful hedging techniques, enroll in the Perfectly Hedged Online Course today. Gain practical skills to increase your profits and confidence in the commodities market.
