Introduction

In a bid to develop the commodity market in the country, the capital market regulator – the Securities and Exchange Board of India (SEBI) – is examining the feasibility of derivatives contracts. Note that derivative trading is one of India's most widely used forms of trading. The introduction of derivatives contracts on freight would go a long way in hedging freight-related price risk for the industry. Read on to learn in detail about freight derivatives and how their implementation would affect markets.

What are freight derivatives?

Freight derivatives refer to financial instruments that derive their values from the movement of freight rates. Those engaged in freight trading use them as a risk management tool. These include ship owners, cargo owners, charterers and traders, among others.

Types of freight derivatives

The different types of freight derivatives are as follows:

• Freight Futures

These are standardised contracts traded on exchanges. These obligate the seller and buyer to deliver a certain quantity of freight at a specific price in the future.

• Freight Forwards

These are similar to freight futures with a slight difference. These are customised contracts that are traded over the counter between two parties. Here, bilateral negotiation takes place on quantity, price and delivery.

• Freight Options

Freight options are like normal options where the buyer has the right to sell or buy freight at a specific price within the said time frame. However, there is no obligation to do the same.

Essential components of freight derivatives

The essential components of freight derivatives are as follows:

• Underlying asset: This asset comprises a particular index or a shipping route.

• Participants: Participants include commodity traders, shipowners, and charterers, among others.

• Settlement: One can do settlement through cash or physically owning the contract's terms.

• Market dynamics: Several factors influence freight rates, such as weather conditions, supply and demand, and geopolitical trends, among others. These can lead to price volatility.

• Regulation: There are specific financial market regulations to which freight derivatives are subject. As a participant, you need to comply with these rules.

Advantages of freight derivatives contracts

Given below are the benefits that freight derivatives contracts bring to the table:

• Acts as a hedge against price volatility

Various factors, such as demand and supply, geopolitical events and weather conditions, can influence freight rates. With freight derivatives, participants can hedge against these price fluctuations. This mitigates the risk of financial losses to a great extent.

• Helps in price discovery

Freight derivatives can help in valuable price discovery. They can do it by aggregating information from various market participants. This enables you to get insights into market trends and helps you make better decisions regarding shipping contracts.

• Aids in risk management

Prudent usage of freight derivatives can help participants manage risk in the shipping market more effectively. They can tailor their risk management strategies to their business goals and risk appetite.

• Helps in portfolio diversification

With freight derivatives, you can effectively diversify your portfolio. You can get exposure to the shipping market dynamics without owning physical vessels. Optimum diversification helps you boost the performance of your overall portfolio. It also helps in effective risk mitigation.

Important things to keep in mind while trading in freight derivatives

Some of the essential things to keep in mind while trading in freight derivatives are as follows:

• Market dynamics

Do keep yourself updated about the factors influencing freight rates, including fuel cost, vessel availability, economic trends, etc. Do analyse market data and understand its impact on freight prices and market sentiments.

• Contract specifications

Do familiarise yourself with the specifics of the freight derivative contracts. These include contract sizes, underlying routes, vessel types, settlement methods, and trading hours. Do understand the terms and conditions to avoid disputes later.

• Counterparty risk

Do assess counterparties' creditworthiness and reliability when entering into freight contracts. Make sure you use the services of reputable brokers and exchanges with robust risk management risk to remain guarded against counterparty risk.

• Regulatory compliance

Make sure to stay compliant with the relevant regulations governing derivatives trading. This is important to avoid regulatory sanctions later.

In conclusion

Prudent usage of freight derivatives contracts can help you mitigate volatility related to freight trading. At the same time, it can help you diversify your portfolio and make meaningful gains in the long run. A Demat account with Motilal Oswal helps engage in derivatives trading hassle-free.

Trending Blogs: Companies affected by Rise in Crude Oil Price | Fall in IT Stocks | Launch of 4 New Indices | Revised Lot Size of Nifty Contracts | RBI Monetary Policy Committee Meet 2024 |   ITC Share Surge After BATs Block Deal | Impact of RBI Circular on Currency Trading | Reliance Revives Campa Cola | Another Jio in Making- Wyzr

Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account

Popular Stocks:   ICICI Bank Share Price | HDFC Bank Share Price | CDSL Share Price | UPL Share Price | TCS Share Price | BHEL Share Price | Trident Share Price | IRFC Share Price | Adani Power Share Price