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.

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.

Learn More About Palladium Futures & Options Trading

Ready to Start Trading Futures?

Trade futures now at OptionsHouse.com with special low introductory contract rates!

To buy or sell futures, you need a broker that can handle futures trades.

OptionsHouse is a full fledged Futures Commission Merchant that provides a streamlined access to the futures markets at extremely reasonable contract rates.

Click here to open a futures trading account at OptionsHouse.com now!

You May Also Like

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

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

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...]

Follow Us on Facebook to Get Daily Strategies & Tips!

Palladium Options & Futures

Futures Basics

Metal Futures

Options Strategy Finder

Outlook on Underlying:

Profit Potential:

Loss Potential:


No. Legs:

Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.

Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2017. TheOptionsGuide.com - All Rights Reserved.