How does Forward Freight Agreements (FFAs) manage the freight risk? Signal Ocean platform reports can help you make the right decision
.jpg)
The daily fluctuations of shipping freight rates are of
great importance to ship owners and charterers involved in the transportation
of bulk commodities. The question is how the interested parties can manage the
intense volatility and the freight risk to minimize the negative impact of
fluctuations on the profitability of a vessel’s employment contract.
The freight market is no different in its functionality
from any other market like commodities or the stock exchange. The movement of
freight rates is driven by the supply of vessels and seaborne demand. The
supply and demand imbalances determine the evolution of freight rates along
with other external factors, i.e. weather status, geopolitical issues,
commodity prices. The oversupply of ships with decreased available cargoes
results in lower levels of freight rates, while more cargo and fewer ships
stimulate an upward direction. The equilibrium between vessels’ supply and
demand-cargoes fuels a steady sentiment in freight rates with no major losses
or profitability for shipping players.
It is important to distinguish the difference between the
physical market and contracts, such as period time charters and contracts of
affreightment with the hedging using derivatives or paper contracts, such as
freight futures, forward, and options on freight rates. The benefits of having
a futures market in freight rates were recognized by the shipping industry
early in the 1960s, however, such a market was eventually established in 1985.
The Baltic Exchange commenced publication of a daily freight index in January
1985. The freight index initially consisted of 13 voyage routes covering
a variety of cargoes from 14,000 metric tons up to 120,000 metric tons, and
this was developed as a settlement mechanism for the establishment of the
BIFFEX futures contract.
The shipping freight indices produced by the Baltic
Exchange have been widely recognized, since their early introduction, as the
most reliable indicators of market conditions in the shipping industry. In the
late 1990s, forward freight agreements replaced the futures contract and by
2006 FFAs were the main derivatives tool.
The value of freight derivatives determines the future
value of freight rates for the seaborne transportation of dry bulk and oil
cargoes. The process for arranging an FFA is similar to that of time charter
contracts; the main difference is that no physical commitment is required. As a
basis for the settlement of the contracts, the Baltic Exchange publishes the
settlement of indices on a daily basis.
Freight derivatives are of great importance to ship owners
and charterers, allowing them to manage the freight risk and hedge against the
fluctuations of freight rates in line with the supply of ships and the relevant
demand of a ship’s employment. The other main types of derivatives including
FFAs are futures, options, swaps.
The
Freight Derivatives Market
What is a Forward Freight
Agreement
FFA is a contract between two counterparties to settle a
freight rate for a specified quantity of cargo for one of the major dry bulk or
tanker shipping routes at a certain date in the future. The underlying route
can be any of the routes that constitute the indices produced by the Baltic
Exchange. FFA contracts are settled in cash on the difference between the
contract price and an appropriate settlement price. This is usually the average
rate of the route over the last seven days of a month, or the average hire rate
over a month for the selected time charter routes.
Futures and Options
The freight derivatives are traded either as freight
futures or options at different expiry dates, while the clearing is taking
place at major clearinghouses, under specific requirements. For the dry FFA
contracts, the clearing exchanges are the European Energy Exchange (EEX) and the
Singapore Exchange (SGX). In the dry bulk segment, FFA contracts are for the
most common vessel sizes, Capesize, Panamax, and Supramax.
What’s
the difference between Futures and Options
Freight option contracts are financial agreements with the
same main characteristics as futures contracts, i.e. different expiry dates on
the forward curve starting from the first month and up to six calendar years,
cleared on a regulated financial exchange. The main difference is that there
are two types of freight options contracts: call options and put options.
A call option is
a contract that gives its buyer the right, but not the obligation, to buy an
underlying asset (freight rate) from the seller (or writer) of the call option
at a certain price known as the strike price at a certain expiration date. On
the other hand, a put option gives
its holder the right, but not the obligation, to sell the underlying asset to
the writer of the put option at a certain strike price and expiration date.
Check the full story here
