Forward Freight Agreements (FFAs)

The Capesize FFA is arguably the segment within the family of freight derivative products that provides the best indicator of market direction. In terms of the routes traded, port flexibility and product carried, this vessel size is the most limited. Iron ore and both steam and coking coal are the drivers for the underlying physical market.

Increasingly, capesize FFAs offer considerable liquidity in the short and medium terms and also progressively offering strategies for longer term trading/hedging opportunities, often up to 2-3 years forward.

Currently, the most liquid trading is found on the average of the four Time Charter Routes using a variety of days and quarters. Of the individual routes, C4 and C7 currently account for approximately 10% of all FFA trades. Traded routes on the Baltic Capesize Index (BCI) are the Richards Bay/Rotterdam C4, Bolivar/Rotterdam C7, and the Average of the 4 Time Charter Routes.

Panamax FFAs are the most widely traded product within the freight derivatives marketplace. Given the consistent increase in the number of companies that are using panamax derivatives, this subdivision of the business offers encouraging opportunities for its participants—principally panamax owners and charterers, grain houses, coal traders, iron ore and steel suppliers and financial institutions.

The product also boasts of widespread geographic coverage, with bid/offer prices readily available on the Pacific Round, Continent/Far East, US Gulf/Japan and Time Charter Routes. Consequently, over the recent past the market has also seen a rise in paper traders who utilise the market's liquidity to control freight market exposure.

The commencement of Supramax FFA trading was a direct consequence of growing industry concerns over the lack of a suitable hedging tool to manage the large price swings as seen in the early to late 1990s.

Supramax derivatives have provided a good mechanism for the minor bulk shipping market participants to manage and control their exposure to the prevailing volatility in Supramax freight rates.

A relative upsurge in trading activity has also given clear direction to owners and charterers looking to take advantage of the paper market to hedge their long-term earnings in addition to providing options for short and medium-term price cover.

The Handysize is the smallest but most common vessel in the dry bulk sector. Trading in this category was originally on a trial basis but due to a growing demand it became fully active in 2007. Handysize FFAs provide good hedging opportunities for the minor bulk shipping participants.

With the amount of physical opportunities open to the Handysize, there is potential for a much more sophisticated and liquid marketplace. As with the supramaxes, the average of the time charter routes is the most widely-traded instrument.

Situation

May 1 – Shipowner charters out his 75K dwt Panamax in the spot market on a 60-day contract at $15,000 per day. He thinks that freight rates will drop in the near future and wants to lock in the rate that he can charter out his ship after the current contract expires.

1. On May 1 – Shipowner sells a Q3 Panamax 4TC contract (20 day per month) for $12,250.
2. On Aug 1 – Shipowner receives his ship back and fixes it out on another 60-day contract at the prevailing rate of $11,000 per day.
3. On Aug 1 – Closes out his FFA position by buying back a Q3 Panamax 4TC contract (20 days per month) for $10,000 per day.

Calculations

Receipts from chartering out ship on 60 day contract: $11,000 x 60 days = $660,000
Profit from closing out FFA position: ($12,250 - $10,000) x 60 days = $135,000
Total receipts: $795,000 or $13,250 per day

Conclusions

Shipowner manages to secure his subsequent fixing on a 60 day contract at $13,250 per day (a rate which is $2,250 better than the current market rate) from the use of FFAs. The shipowner can then continue to pursue such a policy further on by buying/selling FFAs should he find rates attractive and wants to lock them in again.

Situation

May 1 – Trader thinks that current freight rates are too depressed and is bullish about freight rates rising towards the end of the year. He has the option to either buy a ship to take advantage of or buy an FFA. To avoid having to pay cash up front, trader decides to buy an FFA.

1. On May 1 - Trader buys a Q4 Capesize 4TC full contract (30 day per month) for $21,500.
2. Keeps the position open and settles the position in Oct, Nov and Dec respectively based on the settlement price of $28,500, $26,750 and $31,000 respectively.

Calculations

Oct settlement: ($28,500 - $21,500) x 30 days = $210,000
Nov settlement: ($26,750 - $21,500) x 30 days = $157,500
Dec settlement: ($31,000 - $21,500) x 30 days = $285,000
Total profits from FFA: $652,500