Platinum producers can hedge against falling platinum price by taking up a position in the platinum futures market.
Platinum producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of platinum that is only ready for sale sometime in the future.
To implement the short hedge, platinum producers sell (short) enough platinum futures contracts in the futures market to cover the quantity of platinum to be produced.
A platinum mining firm has just entered into a contract to sell 5,000 troy ounces of platinum, to be delivered in 3 months' time. The sale price is agreed by both parties to be based on the market price of platinum on the day of delivery. At the time of signing the agreement, spot price for platinum is USD 964.00/oz while the price of platinum futures for delivery in 3 months' time is USD 960.00/oz.
To lock in the selling price at USD 960.00/oz, the platinum mining firm can enter a short position in an appropriate number of NYMEX Platinum futures contracts. With each NYMEX Platinum futures contract covering 50 troy ounces of platinum, the platinum mining firm will be required to short 100 futures contracts.
The effect of putting in place the hedge should guarantee that the platinum mining firm will be able to sell the 5,000 troy ounces of platinum at USD 960.00/oz for a total amount of USD 4,800,000. Let's see how this is achieved by looking at scenarios in which the price of platinum makes a significant move either upwards or downwards by delivery date.
As per the sales contract, the platinum mining firm will have to sell the platinum at only USD 867.60/oz, resulting in a net sales proceeds of USD 4,338,000.
By delivery date, the platinum futures price will have converged with the platinum spot price and will be equal to USD 867.60/oz. As the short futures position was entered at USD 960.00/oz, it will have gained USD 960.00 - USD 867.60 = USD 92.40 per troy ounce. With 100 contracts covering a total of 5000 troy ounces, the total gain from the short futures position is USD 462,000
Together, the gain in the platinum futures market and the amount realised from the sales contract will total USD 462,000 + USD 4,338,000 = USD 4,800,000. This amount is equivalent to selling 5,000 troy ounces of platinum at USD 960.00/oz.
With the increase in platinum price to USD 1,060/oz, the platinum producer will be able to sell the 5,000 troy ounces of platinum for a higher net sales proceeds of USD 5,302,000.
However, as the short futures position was entered at a lower price of USD 960.00/oz, it will have lost USD 1,060 - USD 960.00 = USD 100.40 per troy ounce. With 100 contracts covering a total of 5,000 troy ounces of platinum, the total loss from the short futures position is USD 502,000.
In the end, the higher sales proceeds is offset by the loss in the platinum futures market, resulting in a net proceeds of USD 5,302,000 - USD 502,000 = USD 4,800,000. Again, this is the same amount that would be received by selling 5,000 troy ounces of platinum at USD 960.00/oz.
As can be seen from the above examples, the downside of the short hedge is that the platinum seller would have been better off without the hedge if the price of the commodity went up.
An alternative way of hedging against falling platinum prices while still be able to benefit from a rise in platinum price is to buy platinum put options.
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