A quick guide and tool for those
watching and wondering about the evolution of futures contracts
and indices, tools that aim to bring stability to the ferrous
What is a futures contract?
Futures contracts are financial risk management tools.
A futures contract is a contractual agreement to buy or sell a
commodity or financial instrument at a pre-determined price in
the future, enabling companies to hedge risks associated with
general economic and market factors. A futures contract details
the quality and quantity of the underlying asset. Some futures
contracts call for physical delivery of the asset, while others
are settled in cash. Exchange-traded futures contracts are
available for many commodities and financial instruments, such
as nonferrous metals, oil, currencies, indices, equities, bonds
and, more recently, steel and scrap.
What are ferrous scrap
Like steel futures contracts, scrap contracts are a
financially settled derivative, which means there wont be
actual physical delivery of the product. Scrap futures provide
dealers, consumers and generators of scrap a tool to offset
price risk in a given price scenario, like protecting inventory
in a downward move or to lock in prices forward for longer
periods. CME Group Inc. managing director of metal products
Harriet Hunnable said the scrap contract is an effective
tool to enable price risk management throughout the entire
supply chain, from raw materials to finished steel products. In
addition to being an efficient risk-management tool for
regional industry participants, we firmly believe our U.S.
Midwest scrap futures contract has the potential to become a
global benchmark for price discovery and managing volatile
How do they work?
When employing a financially settled contract,
everything you do on the physical side stays the
same, said Young-Jin Chang, CME Groups director of
metals research and product development. All youre
doing is on the financial side and accounting side; youre
trying to hedge some of that volatility and fix your profits so
you can somewhat more stabilize your business if that makes
sense for your business.
How are ferrous scrap
futures contracts settled?
The contract, available for trading on CME Globex for
submission for clearing through CME ClearPort, is financially
settled against AMMs U.S. Midwest Ferrous Scrap
Index. The first CME Group product based on AMMs
price assessment services is designed to offer risk management
for the steel industry based on market data from
Who is CME Group?
As the worlds leading and most diverse
derivatives marketplace, CME Group is where market players
attempt to manage risk. CME Group exchanges offer a range of
global benchmark products across all major asset classes,
including futures and options based on interest rates, equity
indices, foreign exchange, energy, agricultural commodities,
metals, weather and real estate. CME Group operates its CME
Globex electronic trading platform and trading facilities in
New York and Chicago.
What is hedging, and is
Hedging is about decreasing or transferring risk. It
can help any business that needs to reduce its exposure to
adverse and unpredictable price movements. It is a risk
management strategy used to limit or offset the probability of
loss from fluctuations in the prices of commodities, currencies
or securities. Hedging employs various techniques, but
basically involves taking equal and opposite positions in two
different markets, such as cash and futures markets. Many steel
mills already hedge currencies and energy sources, and others
hedge some or all of their raw material purchases. The
possibility of hedging is open to all in the industry: brokers,
dealers, mills, traders, end-users and others.
Why scrap futures now?
When CME Group added the first ferrous scrap futures
contract available to the North American steel industry to its
product suite on the Nymex exchange, it was a reaction to
volatility in the ferrous scrap market. The U.S. Midwest scrap
futures contract has the potential to do for steel raw material
prices what West Texas Intermediate futures contracts have been
for oil--a global benchmark and liquid product that can help
the industry manage volatility. The global economy shifted the
dynamics of business, creating a need for such a contract to
help mitigate exposure to wild fluctuations prevalent in the
scrap and steel industries. Volatility is here to stay
and globalization is inevitable, Chang said.
What is AMM U.S. Midwest Ferrous Scrap
The index, launched in June 2012, is quoted in U.S.
dollars per gross ton, delivered to the mill. The AMM
index methodology is a tonnage-weighted calculation of
transactions that have been normalized to a base specification
using value-in-use curves as defined by the market. This
methodology uses the input of high-quality data. The index is
based on actual transactions reported to AMM by any
market participant conducting trades on a
delivered-Midwest-mill basis and isnt restricted to a
panel or select group. The U.S. Midwest Ferrous Scrap Index
also utilizes aggregate transaction data, where available, to
maximize the proportion of the market represented in the final
The scrap futures market
is off to a slow start. Is this a bad omen for its fate?
More than 3,000 tons were traded in October, the first
full month for the futures contract, which was seen as a
positive sign for the new hedging tool. This is actually
very good considering this is a very new market. We see this as
a very positive sign for growth, Chang said at the time.
Participants are hedging small tonnages of 20 to 100 tons of
busheling to try the contract out. December saw the lowest
interest since the contracts launch. As of the end of
February, open interest stood at 4,800 tons, calculated through
August, and 6,340 tons have cleared so far in 2013. Other
futures markets, including those for finished steel products,
also started off slowly, so the cautious reception thus far
doesnt mean it will remain a less-popular market
What about the idea that
futures are an unknown to the scrap industry?
Scrap metal was one of the last few major commodities
without a futures contract. The big question is whether the
players in the market will use the contract. Scrap players up
and down the supply chain say the new hedging tool has piqued
their interest, even as others remain wary of the fledgling
product. Chang said inquiries into the new product have been
flowing in steadily since June 20, when the CME first announced
its licensing agreement with AMM. Were
getting quite a few inquiries coming from scrap participants:
scrapyards, processors and (steel) producers. Theyre
inquiring about learning more about the contract and
understanding it. Of course, there will be a learning
curve, she said.