Hedging (price-risk management)
Offsetting the price risk of physical buying and selling by taking an opposite position in derivatives such as futures, forwards, options or swaps. A cable maker taking copper in three months can buy LME copper futures today to protect against a price rise, while a trader that has sold at a fixed price sells futures. Forward FX contracts manage currency risk in the same way. Hedging is not speculation: the aim is to protect the margin rather than to make a profit, though margin calls and basis risk must be managed.
Related terms
London Metal Exchange (LME) and commodity exchanges
The exchange that sets global reference prices for non-ferrous metals such as copper, aluminium, zinc, nickel, lead, tin and cobalt; its official prices and monthly averages are used as indices in physical contracts. A physical buyer pays the LME price plus a premium that depends on origin, brand and delivery location (e.g. the Rotterdam aluminium premium). Other key exchanges: CME/COMEX (copper, gold), ICE (Brent, cocoa, coffee, sugar, cotton), CBOT (soybeans, corn, wheat), SHFE (Shanghai metals), DCE and ZCE (Chinese plastics, iron ore and agricultural futures) and Bursa Malaysia (palm oil).
Formula pricing (index-linked pricing)
A method in which the price is tied to a market index instead of a fixed figure – for example “LME copper average of the shipment month + USD 85/t premium”, “Platts Dated Brent + USD 2.50/bbl” or “ICIS PP homopolymer CFR Türkiye monthly average minus 1 %”. The pricing period (B/L month, arrival month or quotational period, QP), the index source and the exchange rate used for payment must be stated clearly in the contract. In term contracts it protects both parties fairly against price swings.
Contango and backwardation (forward curve)
Terms describing futures prices relative to the spot price. In contango, deferred prices are above spot, usually reflecting ample supply and the cost of carry – storage, financing, insurance – which makes holding stock and selling forward attractive. In backwardation, spot is above futures, signalling a tight market where prompt material is scarce and pushing buyers to secure supply quickly. The shape of the curve is an important signal for raw material stock policy and contract timing.