Although trading in dry cargo Freight Forward Agreements (FFAs) is relatively new, with the earliest transactions occurring little more than a decade ago, in 1992, it is simply an evolution of the shipping option, which is a venerable concept. Shipping options have been around for thousands of years and were popular during ancient Roman and Phoenician times, for example
An option is a contract that gives the buyer the right, but not the obligation, to buy (a “call” option) or alternatively sell (“put” option) the underlying instrument at a specified price in the future
With FFAs:
» The buyer of a call option will benefit from a rise in FFA prices. Conversely, the seller of a call option will benefit from stable or falling FFA prices
» The buyer of a put option will benefit from falling FFA prices. Conversely, a seller will benefit from stable or rising FFA prices
The main uses of options are for speculating or hedging
As with any market, there are risks associated with speculating. The advantage of buying an option is that the maximum loss is limited to the premium paid
Hedging can be thought of an insurance policy; for example, an owner who wants to protect against a fall in freight prices while preserving the ability to benefit from a rise in prices would buy a put option
The buyer of an option knows the maximum loss at the time of the trade. A seller knows the maximum profit. Therefore, a seller has an element of risk associated with the transaction, and is most likely to sell an option only at a price that will compensate for that risk
Options are traded in almost exactly the same way that the underlying FFAs are transacted. Buyers and sellers of options agree on a strike price (the price at which the contract may be exercised), and then negotiate a premium (the price to be paid for the right to buy or sell). The premium is quoted in $/day for Time Charters (TC), and $/tonne for Capesize routes
Option contracts are executed between two counterparties through a broker, either as an over-the-counter contract or cleared through NOS, the Norwegian futures and options clearinghouse for international commodities markets, or London-based LCH-Clearnet, which launched its dry freight options clearing service in February 2008
FFA options are traded in exactly the same sizes as the underlying FFA contracts—i.e., Q1–08 = 91 days, Cal–09 = 365 days
For example:
Assume that XYZ is the buyer of a Panamax Average TC Q34–08 $50,000 put option, and the premium agreed with the seller was $4,000 per day. The total premium payable would be $4,000 x 184 = $736,000. This premium must be paid within five business days of the trading date
FFA options also settle in exactly the same way as the underlying FFA contracts—i.e., monthly in arrears. Therefore, in the example above, if any of the months of Q34–08 settle below $50,000, the seller of the option would have to pay to the buyer of the option the difference times the number of days for that month. If any of the months settle above $50,000, no further monies change hands
FFA options are European-averaged (or Asian style) and automatically settled at the end of the contract. No prior notification is required
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