Difference between physical and financial energy trading
The difference between the two represents the amount of payment due one party or the other. The calculations are the same as those shown in Lesson 9's hedging spreadsheet. The advantage of using Swaps for hedging is that you can achieve the same price protection without actually having to buy or sell NYMEX contracts. In a previous lesson and, in the textbook, we discussed the fact that physical entities wishing to hedge must take a position in the financial market which is the opposite of their physical position.
For instance, a crude oil producer is "long" the commodity. Therefore, in order to execute a proper hedge, they must go "short" in the financial derivative they choose. In Lesson 9, I presented how the physical and financial prices interact in a hedge. Skip to main content. Financial Energy Swaps Print Swaps represent exchanges of payments between two parties. Key Learning Points for the Mini-Lecture: He multiplies bushels by 60 acres and gets 10, bushels of Corn. Each Corn Futures contract calls for 5, bushels.
The farmer would probably sell 2 Futures contracts to hedge his crop for the year. The exchange also will list the grade of Corn the farmer can deliver. This Corn will be inspected to make sure it meets or exceeds the grade specification. After the inspection who ever receives the Corn through the delivery process will be assured it is of good quality.
Imagine if ranchers did not receive good quality Corn and they fed their livestock with it. I wrote about contango and inverted markets in previous articles. When looking for these characteristics, make sure the Futures contract is a physical delivery type.
The majority of Commodity Futures contracts traded on United States exchanges can be physically delivered. This does not apply to just the Agricultural Commodities. Each Commodity Futures contract will have its own unique specifications.
It is important to understand the market you are trading. Here are two links to the most popular Futures exchanges:. That is the process if you actually wanted to have it delivered to you. You will likely just offset your position by buying back if you sold first or selling back if you bought the contract first.
Your broker has all your positions monitored on a risk server and will know anytime you get close to a delivery situation. As time draws near to a First Notice Day delivery situation and you still have an open position your broker will notify you and ask your intentions.
Brokers are responsible for any losses or fees you might cost the clearing firm where you have your account. These losses come out of his pocket, not the brokerage firm. There are some Commodity Futures contracts that do not have a physical delivery. These contracts are settled in cash. If a Commodity cannot be stored for a long period of time due to spoilage or other logistics the contract resorts to a cash settlement.
Currently there are two Commodities and a Sector that have cash settlement. From its birth a pig takes about 6 months to reach slaughter weight of pounds. When a hog weighs pounds live weight it will yield about pounds of lean pork. The Commercial traders found it was better to hedge this widely used portion of the hog instead of the entire live hog.
Since this lean hog meat cannot be stored indefinitely the exchanges created a cash settlement. Live Cattle are calves to the point when they are about pounds which takes about months from birth. After they reach this weight they are transferred to feedlots where they become known as Feeder Cattle.
Here they will remain for about 5 more months until they put on approximately more pounds. At this point they are usually slaughtered and sent to meat processors for packaging. Leaving the feed lot the average slaughter weight is about 1, pounds.