Hedging Against Rising Palladium Prices using Palladium Futures

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Hedging Against Rising Palladium Prices using Palladium Futures

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

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

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

Palladium Futures Long Hedge Example

An automaker will need to procure 10,000 troy ounces of palladium in 3 months’ time. The prevailing spot price for palladium is USD 185.40/oz while the price of palladium futures for delivery in 3 months’ time is USD 190.00/oz. To hedge against a rise in palladium price, the automaker decided to lock in a future purchase price of USD 190.00/oz by taking a long position in an appropriate number of NYMEX Palladium futures contracts. With each NYMEX Palladium futures contract covering 100 troy ounces of palladium, 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 10,000 troy ounces of palladium at USD 190.00/oz for a total amount of USD 1,900,000. Let’s see how this is achieved by looking at scenarios in which the price of palladium makes a significant move either upwards or downwards by delivery date.

Scenario #1: Palladium Spot Price Rose by 10% to USD 203.94/oz on Delivery Date

With the increase in palladium price to USD 203.94/oz, the automaker will now have to pay USD 2,039,400 for the 10,000 troy ounces of palladium. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the palladium futures price will have converged with the palladium spot price and will be equal to USD 203.94/oz. As the long futures position was entered at a lower price of USD 190.00/oz, it will have gained USD 203.94 – USD 190.00 = USD 13.94 per troy ounce. With 100 contracts covering a total of 10,000 troy ounces of palladium, the total gain from the long futures position is USD 139,400.

In the end, the higher purchase price is offset by the gain in the palladium futures market, resulting in a net payment amount of USD 2,039,400 – USD 139,400 = USD 1,900,000. This amount is equivalent to the amount payable when buying the 10,000 troy ounces of palladium at USD 190.00/oz.

Scenario #2: Palladium Spot Price Fell by 10% to USD 166.86/oz on Delivery Date

With the spot price having fallen to USD 166.86/oz, the automaker will only need to pay USD 1,668,600 for the palladium. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the palladium futures price will have converged with the palladium spot price and will be equal to USD 166.86/oz. As the long futures position was entered at USD 190.00/oz, it will have lost USD 190.00 – USD 166.86 = USD 23.14 per troy ounce. With 100 contracts covering a total of 10,000 troy ounces, the total loss from the long futures position is USD 231,400

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the palladium futures market and the net amount payable will be USD 1,668,600 + USD 231,400 = USD 1,900,000. Once again, this amount is equivalent to buying 10,000 troy ounces of palladium at USD 190.00/oz.

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Risk/Reward Tradeoff

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

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Understanding Put-Call Parity

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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. ]

Hedging Against Falling Palladium Prices using Palladium Futures

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

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

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

Palladium Futures Short Hedge Example

A palladium mining firm has just entered into a contract to sell 10,000 troy ounces of palladium, to be delivered in 3 months’ time. The sale price is agreed by both parties to be based on the market price of palladium on the day of delivery. At the time of signing the agreement, spot price for palladium is USD 185.40/oz while the price of palladium futures for delivery in 3 months’ time is USD 190.00/oz.

To lock in the selling price at USD 190.00/oz, the palladium mining firm can enter a short position in an appropriate number of NYMEX Palladium futures contracts. With each NYMEX Palladium futures contract covering 100 troy ounces of palladium, the palladium mining firm will be required to short 100 futures contracts.

The effect of putting in place the hedge should guarantee that the palladium mining firm will be able to sell the 10,000 troy ounces of palladium at USD 190.00/oz for a total amount of USD 1,900,000. Let’s see how this is achieved by looking at scenarios in which the price of palladium makes a significant move either upwards or downwards by delivery date.

Scenario #1: Palladium Spot Price Fell by 10% to USD 166.86/oz on Delivery Date

As per the sales contract, the palladium mining firm will have to sell the palladium at only USD 166.86/oz, resulting in a net sales proceeds of USD 1,668,600.

By delivery date, the palladium futures price will have converged with the palladium spot price and will be equal to USD 166.86/oz. As the short futures position was entered at USD 190.00/oz, it will have gained USD 190.00 – USD 166.86 = USD 23.14 per troy ounce. With 100 contracts covering a total of 10000 troy ounces, the total gain from the short futures position is USD 231,400

Together, the gain in the palladium futures market and the amount realised from the sales contract will total USD 231,400 + USD 1,668,600 = USD 1,900,000. This amount is equivalent to selling 10,000 troy ounces of palladium at USD 190.00/oz.

Scenario #2: Palladium Spot Price Rose by 10% to USD 203.94/oz on Delivery Date

With the increase in palladium price to USD 203.94/oz, the palladium producer will be able to sell the 10,000 troy ounces of palladium for a higher net sales proceeds of USD 2,039,400.

However, as the short futures position was entered at a lower price of USD 190.00/oz, it will have lost USD 203.94 – USD 190.00 = USD 13.94 per troy ounce. With 100 contracts covering a total of 10,000 troy ounces of palladium, the total loss from the short futures position is USD 139,400.

In the end, the higher sales proceeds is offset by the loss in the palladium futures market, resulting in a net proceeds of USD 2,039,400 – USD 139,400 = USD 1,900,000. Again, this is the same amount that would be received by selling 10,000 troy ounces of palladium at USD 190.00/oz.

Risk/Reward Tradeoff

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

Learn More About Palladium 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. ]

Palladium Futures

Used in everything from dentistry to groundwater treatment, palladium is by far the most versatile metal investment. Only a little while ago, palladium was not nearly as popular as it is today, but due to the incredible economic growth in developing countries—especially China—this jack-of-all-trades metal is steadily growing in importance in the futures markets.

Palladium Contract Specifications
Product Symbol PA
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 7:30am-12:00pm CT
Contract Size 100 troy ounces
Price Quotation U.S. Dollars and Cents per troy ounce
Minimum Fluctuation $0.05 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 March, June, September, and December.
Settlement Type Physical
Settlement Procedure Daily Palladium Futures Settlement Procedure
Final Palladium 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 Palladium 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

Palladium Facts

Palladium futures can be used as a hedging tool for both producers and consumers of palladium alike. Palladium futures also offer advantages like central clearing and transparency of price among traders.

The top leader in palladium production is Russia, followed by South Africa, and North America. Palladium is part of the same metals group as platinum and they are considered to be alike. However, palladium is more common than platinum because it can also be produced via a derivative of nickel mining. Palladium is mainly used for production in the automobile industry, specifically for automotive catalysts. Palladium is also used in electronics.

Last updated May 2020

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