Hedging Terminology

Arbitrage (arb): The simultaneous buying and selling of a commodity to exploit price differences in two different markets for that same commodity.

Asian Options: The strike price of the option is based on the average price of the commodity over a defined period.

Assays: The chemical analysis of a commodity.

Average Price: The price will be set over the average of a given number of days; this could be a full month(s) or partial month average.

Backwardation: The price is decreasing with time.

Bid: The price at which you could sell.

Borrow: Buying a nearby prompt date and selling a further out prompt date simultaneously.

Buyer’s Option (QP): The buyer of a commodity has the option to declare all or parts of a QP.

Call Option: Gives the holder of the option the right to buy futures at a predetermined strike price, at a specific expiration date in the future.

Carry Trade: Also known as a spread trade, this is the collective term for borrowing and lending.

Cash: A trade that is prompt two business days after the day it is traded.

Cash Settled: Trades that become prompt without being closed out are settled in cash against an agreed-upon pricing mechanism.

Contango: The price is increasing with time.

Easing: The size of a contango is increasing, or the size of a backwardation is decreasing (pages 42).

European Option: The strike price of the option is based on the price of the commodity at a specific point in time.

Exchange: An institution used for the trading of commodities, such as the London Metal Exchange (LME), the Chicago Mercantile Exchange (CME), and the Shanghai Futures Exchange (SHFE).

Final Weights: The agreed-upon exact weight of a physical commodity purchase or sale.

Fixed Price: The price of the commodity for a purchase or sale has been agreed upon, often at the time of confirming the contract.

Foreign Exchange (FX) Hedging: The buying or selling of a foreign currency to mitigate exposure to changes in foreign exchange rates.

Forward Curve: Defines the value of a commodity for future prompt dates based on a single price. How far into the future the forward curve exists will depend on the commodity being traded.

Full Finance: The cost of financing an LME/CME warrant plus the cost of LME/CME warehouse rent.

Futures Contract: An agreement to buy or sell a specified tonnage of a commodity at an agreed-upon price, at a specific date in the future.

Initial Margin: A down payment required to cover a percentage or fixed amount of the value of the futures trade.

Kerb: The last of the four daily sessions on the LME.

Lend: Selling a nearby prompt date and buying a further out prompt date simultaneously.

Leverage: Executing trades with a larger nominal value than you are required to finance at the point of execution.

Long Position: You have bought a commodity.

Lot: The defined volume a commodity trades in on an exchange. For example, one LME lot of copper is equal to 25 mt.

Lowest of the Fours: The lowest official price set by the LME during the second ring between cash bid, cash offer, 3M bid, and 3M offer.

M: The scheduled month of shipment.

M-1/M-2/M-3: A minus sign after M, signals prior; M-1 would be one month prior to the scheduled month of shipment; M-2 would be two months prior to the scheduled month of shipment, and so on.

M+1/M+2/M+3: A plus sign after M, signals after; M+1 would be one month after the scheduled month of shipment, M+2 would be two months after the scheduled month of shipment, and so on.

Market on Close: The official closing kerb price posted by the LME.

Margin Call: The value of a company’s combined margin has exceeded any established credit line. This exposure is required to be financed in cash once a margin call is issued.

MOAS: Month of actual shipment.

MOAS +/-: Similar to when using M, plus and minus can also be added to MOAS to define prior or after.

Mutually Agreed: Both buyer and seller of a commodity must agree to the terms of the QP.

Offer (Ask): The price at which you can buy.

Official Cash Settlement Price: The official cash offer price set by the LME during the second ring.

Open Outcry: A method of trading whereby traders set prices and transact verbally or using hand signals on a physical trading floor.

Order Depth: The number of lots available to sell or buy at a given price.

Option Premium: The cost the holder of an option contract will pay, or the amount the seller of an option contract will receive.

Perfect Hedge: Hedging to the exact same volume as your physical trade, at the exact same price.

Physically Settled: Trades that become prompt without being closed out become an obligation to either deliver metal into an exchange-approved warehouse, or take delivery of metal from an exchange-approved warehouse.

Premium: A value over and above the exchange set price for a commodity.

Premium Hedging: Mitigating the risk of buying or selling metal at an unknown future premium.

Price-agnostic: The price movements after fixing the price of a commodity do not affect the gross profitability of that contract.

Price Participation: An agreement between a buyer and a seller of concentrates whereby the treatment charge increases if the underlying price of the commodity breaches a defined level.

Pricing Option: A target level for a futures trade on the SHFE.

Prompt Date: The date a futures contract settles.

Put Option: Gives the holder of the option the right to sell futures at a predetermined strike price, at a specific expiration date in the future.

Qualified Foreign Institutional Investor (QFII): A license required to trade futures contracts on domestic Chinese exchanges.

Quotational Period (QP): Defines the terms of how the price will be fixed for a physical contract.

Ring: The name of the trading floor at the LME and also the name given to each session of trading.

Scales: An agreement between a buyer and a seller of concentrates whereby the treatment charge increases if the underlying price of the commodity breaches a defined level.

Seller’s Option (QP): The seller of a commodity has the option to declare all or parts of a QP.

Short Position: You have sold a commodity.

Sifting: Picking up a large number of warrants in the hope of obtaining specific material without needing to pay a premium and delivering back the unwanted warrants.

Spread Card: A report that details a company’s current and forward positions to view their spread exposure in every month which they have a position.

Third Wednesday: The most liquid prompt date on the LME each month. Also, the prompt date you are trading if you buy or sell a month. For example, if you buy ‘December’, your trade will be prompt the third Wednesday of December.

Trade at Settlement (TAS): The daily settlement price posted by the CME, sometimes still referred to as MOC.

Three-Month Price (3M): The standard price (and prompt date) quoted on screen for LME trading.

Tightening: The size of a contango is decreasing, or the size of a backwardation is increasing.

Tolerance: The tonnage a final delivery can differ from the contractual tonnage, usually expressed as a percentage.

Tom: A prompt date that is one business day after the current trading day.

Treatment and Refining Charges: The amount the buyer of concentrates charges the seller of concentrates to process the material.

Unknown Price: The price of a physical contract remains to be fixed.

Variation Margin: The difference in value between the price of an executed futures trade and the current market price.

Warrant: The physical parcel of metal that backs each lot of metal traded on a physically backed exchange.