London Metal Exchange - LME
The LME can trace its origins back to 1571 although it was formally established in 1877 as the London Metal Market and Exchange company. Today it is the world's largest non-ferrous metals exchange.
The LME trades futures and options contracts in Aluminium, aluminium alloy, North American Special Aluminium Alloy (NASAAC), copper grade A, zinc, tin, primary nickel, standard lead and Silver. It also trades traded average price contracts (TAPOs) for aluminium and copper grade A, aluminium alloy, North American Special Aluminium Alloy (NASAAC), standard lead, primary nickel, tin and zinc. London Metal Exchange Traded Average Price Options (TAPOs) for copper grade A, high grade primary aluminium, standard lead, primary nickel, special high grade zinc, aluminium alloy and tin are Exchange cleared contracts based on the LME Monthly Average Settlement Price (MASP).
Because many users in the industry price their physical material on the basis of the LME MASP, brokers developed off-Exchange average price option products, known as 'Asians' which quickly became popular, particularly with large producers. To meet this growing demand, the LME developed the TAPO contracts.
TAPO contracts complement existing LME futures and traded options contracts. Users of the market who trade basis the MASP will tend to use TAPO contracts. However, hedgers who trade using the LME's flexible daily prompt system will find futures or traded options more suitable hedging tools.
The exchange introduced futures and options contracts based on an index (LMEX) of its six primary metals in April 2000. In 2000 the daily value of contracts traded on the LME was about $8,000 million and the first six months of the year saw record trading of over 35 million lots equating to $1,400 billion.
The LME market is a combination of floor and inter-office trading cleared by the London Clearing House (LCH). LME membership extends to over 100 companies.
Trading in the London market starts at 7.00am with the premarket session, where members make markets in the various metals from their offices. The trading floor of the LME, called the Ring, opens at 11.40am and each contract trades in turn for a five minute period. There follows a ten minute break from 12.20 to 12.30pm, after which each contract trades again for a five minute period. It is during this second session that the settlement and official prices are determined. After these prices have been announced, usually about 1.15pm, kerb trading commences where all the contracts trade simultaneously until 3.10pm when the afternoon ring trading session follows the same procedure as the morning session. Kerb trading then lasts until 5.00pm but no official prices are issued after the afternoon session. From 5.00pm onwards trading returns to an inter-office basis and continues world wide through the night until focus returns to London in the early morning.
Floor trading in LMEX is only carried out during kerb sessions.
Although the US Dollar is the major currency for each contract, Sterling, Yen and the Euro are also accepted for clearing purposes. The Daily Official Exchange rates are announced after the morning ring session at the same time as the official prices for the metals contracts.
Futures:
Futures contracts are purchases or sales of goods for a specified delivery date in the future at prices established today. On the futures market the goods that underlie the contract are always at a specific stage of production. On the LME, this is at the semi-processed stage, where the raw material has been turned into an easily handled, non-perishable form such as ingots, cathodes, pellets etc. If the delivery of these goods take place, then the futures contract becomes a physical contract. In the main this does not happen. Futures contracts are usually cancelled out by an equal and opposite contract: buy/sell back. This is because futures trading is about price. Sometimes, it is solely about price, buying low/selling high, but usually it’s about price risk and the offsetting of risk by hedging.
The specified delivery date of a futures contract is referred to as the prompt date, by which time either the position must be closed or a delivery will take place. On the LME, the final trading day, the last day a position can be closed, is two days before the prompt date.
An important aspect of LME futures contracts is that, with the exception of the LMEX contract, they are not settled until the prompt date. They are not cash cleared. Initial margins and variation margins against risk exposure will be called during the term of a contract, but the value of a contract is not paid until delivery.
Options:
Option contracts give trade hedgers and investors a more flexible alternative to futures as a means of trading on the Exchange. When buying an options contract, the purchaser (taker) is not entering into a firm obligation. They are simply buying a choice of action. This choice allows the genuine trade hedger the opportunity of locking in a fixed price while maintaining the ability to abandon the option in order to take advantage of favourable price movements. This would be forfeited with a straight futures hedge.
The cost of purchasing the option is referred to as the premium and, unless the option is traded on, this is a write-off. It is not part of the value of the underlying futures contract. This means it is down to the user's perception of the market and the cost of the option as to whether they choose to use futures or options as their hedging medium.
Today, LME-traded option contracts are available against the underlying futures contracts for all LME metals as well as for LMEX.
LMEX:
London Metal Exchange index - is a base metals index comprising the six primary non-ferrous metals traded on the Exchange: aluminium, copper grade A, standard lead, primary nickel, tin and zinc.
The index, launched on 10 April 2000, tracks the performance of the underlying metal contracts traded on the world's premier non-ferrous base metals exchange against this initial evaluation of 1000 set on 4 January 1999.
LMEX futures and traded options contracts have been specifically designed to provide investors with easy access to the world's industrial metals market, without the physical delivery, storage and transaction costs associated with the underlying contracts.
As an exchange developed contract, LMEX offers transparency with the security of clearing, stability through regulation and a global trading structure that are the hallmarks of the London Metal Exchange.
TAPO Contracts:
London Metal Exchange Traded Average Price Options (TAPOs) for copper grade A, high grade primary aluminium, standard lead, primary nickel, special high grade zinc, aluminium alloy and tin are Exchange cleared contracts based on the LME Monthly Average Settlement Price (MASP).
Because many users in the industry price their physical material on the basis of the LME MASP, brokers developed off-Exchange average price option products, known as 'Asians' which quickly became popular, particularly with large producers. To meet this growing demand, the LME developed the TAPO contracts.
TAPO contracts complement existing LME futures and traded options contracts. Users of the market who trade basis the MASP will tend to use TAPO contracts. However, hedgers who trade using the LME's flexible daily prompt system will find futures or traded options more suitable hedging tools.
TAPO Contract Specifications
Contract Metals:
copper grade A, high grade primary aluminium, standard lead, primary nickel, special high grade zinc, aluminium alloy and tin.
Contract date:
The business day on which the contract is traded
Contract Period:
Calendar months up to 27 months forward for copper grade A, high grade primary aluminium, primary nickel, special high grade zinc, and 15 months forward for standard lead, aluminium alloy and tin. Contracts can be traded daily up to and including the penultimate business day of the current month.
Option Type:
Calls and puts based on the monthly average settlement price (MASP)*. No early exercise.
Fixed period: The period between the first business day of the current month and the last business day of the month (inclusive).
Strike Price: $1 Gradations
Currency: US dollars
Minimum Tick Size: 0.01 USD (one cent)
Premium Payment: Next business day after the contract is traded.
Exercise: The exercise process is automatic once the LME monthly average settlement price is made official. A TAPO contract that is 'in-the-money' generates two Futures trades per Member which are equal and opposite in tonnage. One trade corresponds to the MASP and the other to the original strike price of the option.
Settlement Date:
Settlement is two business days after exercise. The futures trades settle as per LME rules and regulations.
Margining:
Like all existing LME contracts, TAPOs are margined using the SPAN methodology.
MASP:
the arithmetic average of all settlement prices determined during the Fixing Period. This becomes an official LME price on the last day of the current month at 3.00pm.
NYMEX / COMEX
The Butter and Cheese Exchange of New York was founded in 1872 by a group of dairy merchants who were trying to bring order and standardization to the chaotic conditions that existed in their industry. Gradually, the product base was broadened and the name was changed to the New York Mercantile Exchange 10 years later.
Over the years, the Exchange shifted towards industrial products. It was the first Exchange to successfully trade energy futures and options with the introduction of the heating oil futures contract in 1978. Today, the Exchange is the world's preeminent energy market and precious metals markets; agricultural products do not trade on the Exchange.
The Exchange's divisions, the NYMEX Division and the COMEX Division, were formed by the merger of the New York Mercantile Exchange and the Commodity Exchange, Inc., in 1994. The trading operations of each exchange were continued as the two divisions, offering trading in their respective futures and options contracts – energy, platinum, and palladium for the NYMEX Division; gold, silver, and copper on the COMEX Division (aluminum was added since the merger). Trading rights on each division are bought, sold, and leased separately, but there are occasions when cross-divisional trading privileges in specific markets are granted to the opposite division.
General Market Information (NYMEX/COMEX)
Stocks and commodities:
Even though stocks and commodity futures are traded on exchanges, they are different instruments. A share of stock represents a position of ownership in a company. A commodity futures contract is an obligation for the holder of the contract to buy or sell a specific quantity of a particular commodity at a specific price and location at a specific date in the future. It is not tied to the product of a particular company, but rather a standardized product that is widely accepted throughout the relevant industry.
Futures contracts:
A: A futures contract is a binding, legal agreement between a buyer and a seller for delivery of a particular quantity of a commodity at a specified time, place, and price. Futures are used as a proxy for cash, or physical, transactions before actual purchases or sales. This allows the buyer to assess his costs in advance of purchase and the seller to value his inventory in advance of sale.
Options contracts:
A: An options contract gives the holder of the contract the right, but not the obligation to buy or sell the underlying futures contract at a certain price for a specified time. On the opposite side, the seller, or writer of an options contract incurs an obligation to perform should the options contract be exercised by the purchaser.
Volume and open interest:
A: Trading volume is the total number of contracts traded in a designated time (such as daily, monthly, annually). Open interest is the number of open or outstanding contracts at a given point in time for which the holders are obligated to the Exchange because no offsetting sale or purchase has been made against it. Open interest is frequently used as an indicator of the level of commercial as opposed to speculative activity in a particular futures or options contract, since hedgers are much more likely to hold long-term positions.
Hedging and speculation:
A: Hedgers and speculators have different goals. Hedgers use the futures markets to help stabilize revenues or costs because they have an offsetting position in the physical market. They do not necessarily seek to profit in the futures markets because a gain or loss in the futures market is usually offset to some degree by the corresponding loss or gain in the physical market. Speculators, or investors, on the other hand, enter the market in order to profit from market volatility and the movement of futures prices because they have no offsetting physical positions. Speculators play a valuable role in assuming the risk of market losses that hedgers are seeking to shift, as well in providing liquidity and narrowing the gap between bids and offers that benefits the markets as a whole.
Setting prices:
A: The Exchange does not set prices. The Exchange provides a neutral, orderly, and transparent trading forum where buyers and sellers can come together and publishes the prices that result from those transactions. The prices that emerge from trading are determined by supply and demand. If there are more buyers than sellers, the price goes up. If there are more sellers than buyers, it goes down.
Settling the futures market each day:
It take 45 minutes to an hour to settle the futures market each day. The settlement price is established by the Exchange settlement committee at the close of each trading session as the official price to be used by the clearinghouse in determining net gains or losses, margin requirements, and the next day's price limits. In contract months with significant activity, the settlement price is derived by calculating the weighted average of the prices at which trades were conducted during the closing range, a brief period at the end of the day. Contract months with little or no trading activity on a given day are settled based upon the spread relationships to the closest active contract month. After the close of trading, all closing range transactions must be entered into the Exchange computer system; there is a brief time window to resolve any discrepancies that arise during that period; the weighted average price is compiled; and the settlement committee must determine the spreads appropriate
for those contract months with limited liquidity.
Settlement prices versus closing prices:
Contract settlements are based on the weighted average of trades during the closing range so the settlement and last trade usually will not be identical. If volume in a specific trading month is limited, particularly near the closing range, those months will be settled based on their spread relationship to the nearest active month. The closing range is the last two minutes of trading except on the last day, when it's the last half-hour.
Spot cash prices:
The Exchange offers trading in futures and options contracts based on delivery in the future. The closest month is commonly referred to as the spot month because its prices move in tandem with the spot/cash market but these transactions on the Exchange are not considered part of the cash market.
Futures and over-the-counter (OTC) trading:
Futures contracts are traded on the Exchange in an anonymous, open, and competitive auction. Pricing, trading volume, and open interest are publicly disseminated through market data vendors. Over-the-counter transactions are conducted between two private parties and specifications can be customized, although they generally reflect industry standards. The Exchange has eliminated one of the key concerns over doing business in the OTC market – counterparty credit risk – by offering its clearing services for deals transacted off-Exchange. This allows buyers and sellers to negotiate the price with trading partners of their choice with the full security of the Exchange clearinghouse behind them. Additionally, margin requirements for cleared OTC transactions are netted against other cleared positions on the Exchange, including futures and short options positions, reducing costs and improving cash flow.
Futures and options contracts and its OTC contracts:
The futures and options contracts are offered for trading on the Exchange and all deals must be transacted according to Exchange and CFTC rules. The forum is neutral, competitive and anonymous. Prices, volume, and open interest are publicly disseminated. The OTC contracts are not traded on the Exchange but simply serve as standards for deals that can be cleared on the Exchange following the completion of the transaction. Other than daily settlement prices, data on these products are not made available on a regular basis, consistent with OTC market practice.
Eligible and registered COMEX Division metals:
A: Registered metals are those metals which meet the standards for delivery under the gold, silver, copper, or aluminum futures contracts as stated in the COMEX Division rules and for which a receipt from an Exchange-approved depository or warehouse has been issued. Eligible metals are those which meet the delivery standards as stated in the rules for which no receipt from an Exchange-approved warehouse has been issued.
|
