What are Freight Futures?

Freight Futures are derivatives contracts that reflect the expected future level of freight rates. Freight futures contracts mainly exist for dry bulk and tanker freight rates. Dry bulk freight futures are monthly contracts and are quoted in US dollars per day.

What are the contract specifications?

Freight futures for dry bulk reflect the future expected price of freight for a specific vessel size over a predetermined period. The most common vessel size contracts are for Capesize, Panamax and Supramax vessels. The contracts are monthly contracts and reflect the average price of spot freight over a month.

How do freight futures settle?

Freight futures contracts settle over the average price of spot freight during the corresponding month. Given freight is intangible, there is no physical delivery. Rather, the contracts settle in cash against the arithmetic average price of spot freight published by the Baltic Exchange. The Baltic Exchange, on a daily basis, publishes a number of freight assessments for various shipping routes reflecting the prevailing level of shipping rates. Such assessments for the corresponding vessel classes are used to calculate the monthly average that freight futures settle against.

For Capesize freight futures contracts, the weighted average of 5 different routes globally is used to derive the daily 5TC Capesize index; for Panamax, 4 different routes is used to derive the daily 4TC Panamax index; for Supramax, the average of 10 different routes is used to derive the 10TC Supramax index. There are also numerous other assessments reflecting prevailing spot prices for different routes.

How do freight futures trade?

Freight futures trade primarily off-exchange on a principal to principal basis. Unlike other futures contracts, a centralized trading screen or exchange that market participants can transact does not currently exist. Rather, through a network of brokers, market participants buy and sell freight futures contracts without dedicated market makers. Given the off-exchange structure of the market, there is the ability to transact on a 24-hour basis, although the “normal” trading hours are mainly London hours, from 3am to 12pm EST time. Some trading also takes place during Asian hours, from 11pm to 3am EST time.

In order to buy or sell a freight futures contract, a market participant would contact a freight futures broker and communicate the trading order. The freight futures broker would attempt to find the matching trade, complete the transaction, and submit such transaction to the exchange for clearing thus creating a cleared futures transaction.

How do freight futures clear?

Freight futures clear through exchanges like other futures contracts, and are subject to similar margin requirements like other futures products. Currently major exchanges provide freight futures clearing, although the most common venues are the Nasdaq Futures Exchange (NFX) and the Singapore Exchange (SGX). Each exchange provides its own rules and its own initial and maintenance margin requirements.

Who are the main brokers that provide freight futures trading?

The main brokers that currently provide dry bulk freight futures trading are: Freight Investor Services (FIS), Clarksons, Simpson Spence Young (SSY), GFI, BRS, and Arrow Shipbrokering.

How can I trade freight futures?

Although individual investors have the ability to trade freight futures, it is quite uncommon. The great majority of market participants are institutions with considerable capital and strong balance sheets supporting such trading. In addition, the non-standardized nature of trading and clearing makes it uneconomical for brokers and clearing members to provide easy access to individual investors as the minimum trading requirements are relatively large thus would not allow for adequate economics for brokering firms to serve individual investors.

What are the advantages of freight futures?

Freight futures are the closest an investor could get in when it comes to the actual shipping markets. Prior to the institutionalization of freight futures, one could get access to the real shipping market only by buying a ship, a task that requires significant capital commitment, extensive operations and considerable risk.

Freight futures provide the opportunity to participate in the actual shipping market in the most cost efficient, direct and simple way without all the cumbersome of owning actual ships. In addition, one can benefit from both rising and falling markets, as freight futures can be bought or sold short (ship-owning is generally considered a “long” position in the market).

The nature of shipping can lead to considerable fluctuations in the price of freight over short periods of time. Ships need time to sail to ports and when demand for dry bulk transportation increases, imbalances between available ships and cargo requiring shipping can occur. During such periods, freight prices tend to increase, sometimes significantly, as additional ships take time to sail to port and offer their services. Once the market balance is restored, freight prices eventually return to equilibrium.

Due to the idiosyncratic nature of shipping, dry bulk rates tend to be uncorrelated to other investments, such as equities, fixed income, currencies or other commodities. Supply and demand of ships is the major driver, and although over longer periods of time economic activity is the major driver for shipping demand, during shorter periods, shipping rates rely only on the ship/cargo balance.

Who are the main market participants in Freight Futures trading?

Freight futures are used for hedging, arbitrage or speculation. The main users of freight futures are physical users and providers of freight. Physical users of freight include iron ore, coal and grain producers, steel mills, coal power plant owners and other commodity producers or raw product manufacturers. In addition, trading houses that have exposure to freight and need to transport physical commodities are also major participants.

On the other hand, providers of freight include ship-owning companies and ship-operating companies. Each of the above groups has different needs and a different approach in the use of freight futures. Financial institutions also participate in the freight futures market: Hedge funds and individual traders use freight futures to speculate, invest or diversify their books. Finally, major banks trade freight futures either on a proprietary basis or for their clients’ accounts.

What is the daily trading volume and the open interest in freight futures?

In 2018, the average daily trading volume in dry bulk freight futures was approximately 5,000 lots per day. The open interest across all dry bulk derivatives contracts currently stands at about 460,000 lots (as of 6/30/2019).

Over the last five years, the average trading volume of freight futures has remained relatively constant at about 4,800 lots per day. Open interest on all freight futures has generally fluctuated between 200,000 and 400,000 lots.