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Chart 4


Source: ADMISI


TAILORED HEDGING IDEAS Once sugar options traders are comfortable managing their options risk, they may be able to  copper market since the early 2000s.


TAILORED HEDGE EXAMPLE FOR CONSUMER OF ICE RAW SUGAR: A sugar consumer is interested in hedging some of their ICE Raw Sugar exposure for Jan2020 - Jun2020, and expects the average market price each month to remain inside the 12cts/lb to 16cts/lb range during that period. By incorporating this price view into the hedging decision, the consumer can get a price advantage within this range in return for taking on market risk outside this range.


Basis this price expectation, the following OTC strategy is possible:


The consumer buys a 6 month strip of Fixed Price Swaps at 12.54 cts/lb (c.f. the market price of  front month Settlement Price in each calendar month, and subject to the following conditions:


ONCE SUGAR OPTIONS TRADERS ARE COMFORTABLE MANAGING THEIR OPTIONS RISK, THEY MAY BE ABLE TO OFFER THE TYPES OF STRUCTURED HEDGE DEALS SEEN IN THE COPPER MARKET SINCE THE EARLY 2000S.


In months Jan2020 through June2020, where the average market front month settlement price is:


• Equal to or greater than 16cts/lb, the Notional Quantity becomes zero in that month (i.e. the hedge is knocked out for that month)


• Greater than 12cts/lb and less than 16cts/lb, the Notional Quantity is bought at 12.54cts/lb


• Less than or equal to 12cts/lb, the Notional Quantity bought at 12.54cts/lb is doubled for that month


 Notional Quantity at Factor 1, i.e. for average front month “market settlement prices” (“MSP”) above 12cts/lb and below 16cts/lb.


Note that the hedge is knocked out for any month where the “MSP” is equal to or above 16cts/lb, and the Notional Quantity is doubled for any month where the “MSP” is equal to or less than 12cts/lb.


By incorporating this price view into the hedging decision, the raw sugar consumer would get a price advantage of 1.59cts/lb below prevailing market prices at inception provided that the “MSP” remained inside the expected range during the hedge period.


In summary, options provide market participants with a wider variety of hedging choices and, provided that futures liquidity is reliable, option markets can develop where little trade existed before.


Rohan Ziegelaar E: metals.desk@admisi.com T: +44(0) 20 7716 8081


22 | ADMISI - The Ghost In The Machine | March/April 2019


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