Difficulty understanding metals hedging
I've been going through various documents explaining how physical metals traders hedge and the explanations seem all over the place. What I'm most confused about is this "average price" that traders all seem to be able to hedge with, and they're always able to buy back their LME transactions at exactly the same price as they sell their metal. Now I think I can understand this if the QP is on a single day (i.e. you price your sale at the same exact date that you close out your short, meaning basis becomes 0 and you earn exactly the contango). But how does this work if you're using average prices?
Let's say QP is Oct 5-Oct 15 and we're buying our metal at September 10. Now how do you hedge on LME when we're talking about 10 different days here? I saw another pdf saying you're supposed to do 10+ different transactions using spreads but that went over my head a bit.
koalamacro is actually a base metals and fx derivatives trader so hopefully he responds for your sake lol
I’m not a metal trader, but say if the volume was 250mt... I would think you’d sell 10 lots on Sept 10, and buy back 1 lot each day between Oct 5-15 to achieve the average QP pricing for the hedge.
Yea, so the overall logic there makes sense to me now. So for your initial hedge, would you be selling 1 contract oct5, one contract Oc6, one contract Oct7 etc. then (in order for the price on the contract to converge exactly to the cash price of each day for the QP)?
More generally, does this sound right to you about the reason we can perfectly hedge metals?--since there's a contract for each day within a three month period (unlike say grains), and since contract prices converge to cash prices on expiry, we can price our sales/purchases during QPs at exactly the same price at which we close out our contract. Meaning the basis (if we call the QP price the "cash price") always becomes zero, and our effective price is exactly cash = futures + 0=futures, which we locked in during the initial hedge.
In short, yes. I understand your rationale but your explanation is a bit confusing. You won’t be selling the Oct 5, etc, you’d be buying them back against your Sept shorts to close out the positions.
Sorry, I'm still learning the terminology here., What I meant to say was in September we would sell the contract expiring on Oct 5, oct 6, oct 7... and in October you would buy them back one by one,day after day.So 10 transactions all on the same day in September (but with different expiry dates ),and 10 transactions spread over 10 days in Oct.
BTW I noticed you deleted your comment about basis not applying here. Does that mean my usage of basis wasn't completely off? Most materials I've found online have been about grain and has led me to think in terms of an effective price that depends on two things: (1) the futures price in September, and (2)the differential between the price you close out your hedge and the price of your ultimate physical purchase/sale, starting Oct 5. I know that this value is always zero if we hedge metals correctly because of how QP and LME works, but in grain this differential can narrow/widen, which ultimately affects the effective price we paid.
Anyway, I hope I'm getting closer to the main idea here. I'm completely new to this and it's pretty overhwlming trying to figure things out.
sorry noob here what’s QP?
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