An Introduction to Freight Derivatives

Brokerage
Trade

FFA
Baltic Exchange

Freight derivative desk

Options
Analytical software

Market data
Clearing
Screen Trade (IMAREX)

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Forward Freight Agreement

(FFA)
What is Forward Freight Agreement?
What are the main principles?
Who is in the market?
How is it being traded?

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What is a Forward Freight Agreement

(FFA)?
An agreement today to BUY or SELL freight at an agreed
rate (contract rate) over an agreed future pricing period.
Traditionally An Over the Counter (OTC), principal to
principal agreement between two parties, a buyer and a
seller.
Currently A mixture of OTC swaps, exchange traded
futures and cleared (but non-exchange traded) futures.
A bespoke product designed to manage the inherent
risks of a volatile market.
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The History
Came into existence in 1985 with the development of
BIFFEX (a weighted basket of freight routes) traded
through LIFFE.
Since October 1991, market developed into Over the
Counter (OTC) Swaps.
In 1999, the BFI was split into 3 separate vessel sizes (BCI,
BPI & BHMI).
In 2006, BHMI discontinued and new index BSI established.
In 2007, BHSI established.

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Number of contracts traded per year

(Given as estimate)
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: GFI Group

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Yearly market values of dry-bulk FFA

contracts (Jan. 1992 Sept. 2005)
35000

Million US dollars

30000
25000
20000
15000
10000
5000
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: Clarksons Securities Ltd.

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The Main Principles

To protect the charterer (a natural buyer) and the shipowner (a
natural seller) from adverse movements in the freight market.
Shipowners: need protection from a falling market SELL FFAs
to offset losses incurred on the physical market.
Charterers: need to protect against a rising market BUY FFAs
to offset paying more for the physical market.
Therefore forward freight is locked in today a flattening of
the financial horizon: easier to form a balanced long-term
strategy.
In todays parlance risk has been managed. (???)
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The main principles profit/loss

profiles
Long FFA
25000
20000
15000
P/L (USD)

10000
5000
0
-5000

10000 15000

20000 25000

30000 35000 40000

-10000
-15000
-20000
-25000
Spot freight

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45000 50000

The main principles profit/loss

profiles
Short FFA
25000
20000
15000
P/L (USD)

10000
5000
0
-5000

10000

15000

20000

25000

30000

35000

40000

-10000
-15000
-20000
-25000
Spot freight

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45000

50000

FFA Mechanics
Prior to trading, one needs to check the following
parameters.

Trading route
Contract month
Quantity/duration
Money/rate
Settlement period
Counterparty/clearing house

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Example of typical trade

Pmx Average all Time Charter Routes
Q4 (Oct-Dec)
92 days
$60000 per day
Average of all day
FFABA (2005)

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Market Participation Dry

Trading
companies 30%

Owners 25%

Banks/Finance
houses 15%
Operators 30%

Source: GFI Group

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Geographical breakdown Dry

USA
20%

Europe
50%
Asia
30%

Source: GFI Group

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Market Participation Wet

Owners
20%

Refineries
15%

Traders +
Financials
65%

Source: GFI Group

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Geographical breakdown Wet

USA
10%

Asia
25%

Europe
65%

Source: GFI Group

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How is it being traded? (General)

OTC via phone-based brokers
Exchange-traded via Imarex/NOS
Cleared via LCH, NOS or SGX (give up trade)
Cleared trades est. 30% total volume +
increasing
Growth of risk management departments
controlling FFA trading
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How is it being traded? (Specific)

Specific hedge - voyage or time charter.
Speculation.
Spreads Time, Vessel, Inter-ocean, Voyage/Time
charter, Implied freight, Inter-commodity spreads.
Freight options most rapidly growing part of FFA
market at the moment.

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Where are we now

Market modernization dramatic changes in trading
styles, speed, and efficiency.
Principles activities are now a more hybrid role.
Hybrid role - part owner, part charterer and part trader.
Shipping and commodity trading companies expanding
into each other markets.
Natural introduction of hedge and investment firms and
financial institutions.

Maritime, Transportation and Management