Question

You are a a silver retailer. You source silver from all over the world and you sell it to your clients. Your main clients are battery manufacturers and circuit manufacturers. Today (July 4th) you buy 10,000 oz of silver at 16 dollars an ounce for your inventories.
If you want to hedge your spot position in the futures market, would you go long or short?
Suppose you expect to sell all this silver over the next six months so you hedge using the December contract2 which is currently trading at 16.20 XAGUSD (20 cts higher than the spot price). Is the curve in contango or backwardation?
What is the MTM of your trade? (Assuming the opportunity cost of money is zero)
After just one month a Californian battery manufacturer comes to your shop and buys 5,000 oz. at 16.40 USD/oz . You close part of your futures position for that exact amount at 16.60. (20 cts higher than the spot price). What is the MTM of your trade?
After two more months a circuit manufacturer comes to your shop and buys the rest of the silver at a spot price of 16.15 XAGUSD. You close the rest of your futures position at 16.35 XAGUSD. (20 cts higher than the spot price). What is the MTM of your trade?
One month later the same circuit manufacturer comes and buys the last 2,500 oz. of silver at a spot price of 16.50, and you close your forward hedge at 16.70 (20 cts higher than the spot price). What is the MTM of your trade?

• Was this hedging strategy successful at eliminating market price risk?

• You sold all of your merchandise at a higher price that you bought it for. Why then your MTM looks the way it does?
Suppose that on the last trade you did, you in fact sold the silver at a spot price of 16.50, but you close the forward position at a price of 16.45. Is the curve in contango or backwardation?

• What would bee your MTM now? Why?

Answer 1

Greetings,

1) Since the retailer has already bought the silver for his inventories, so now he is long on silver i.e. if price of silver goes up, he gains .So he fears of price of silver falling as sale will take place some time and by that time price may fall steeply. So to hedge his spot position, he should go short on the futures contracts.

2) Since the spot price is $16/Oz and futures price is 16.2/Oz, it implies that market is in contango. Market is said to be in contango when futures price is more than spot price and it happens when storage costs of commodity exceeds the convenience yield derived from that commodity.

3) Since opportunity cost of buying/selling of futures contract is zero, it means dealer has contracted to sell @16.2 which he bought @16. So if he square off his both positions currently then M2M profit will be 0.2*10000= $2000

4) Now after 6 months, dealer will sell half of the quantity to battery manufacturer for $ 16.40/Oz. Since now he has exposure left only to half of the quantity so he would like to square off half of the futures contract at current market price i.e. 16.60/Oz.

Futures were bought @ 16.20/Oz and sold @ 16.60/oz. So M2M gain on futures is 5000*(16.60-16.20)= 2000. Further there will be gain on spot position to the tune of 5000*(16.40-16.00) = $2000.

Note - 4 parts have been answered, kindly post separate question for remaining parts.