The prominent feature of an FFA contract is its flexibility which gives it an advantage over purely physical hedging.

As an example, an Owner may choose to physically hedge by time chartering out a vessel for a period of 1+ years which has the advantage of securing an income stream and gives the Owner the ability to better manage their cashflow.

A key downside however is that the Owner is entirely exposed to counterparty risk i.e. risk of default by the other contracting party. Another inflexible factor relates to time; time spent finding counterparties and then negotiating a lengthy contract, as well as unavoidable time constraints due to the specific vessel itinerary. Lastly, once the contract is agreed it is not a simple process to reverse the decision and is likely to become costly for the Owner.

In comparison, the advantages of an FFA contract are:

  • The contract duration can be for as short as five days or for multiple years.
  • A required hedge period can also be split between shorter FFA contracts to price by month, quarter or year, rather than a flat price for the entire duration.
  • An FFA contract can commence when required i.e. the current month, the following month, Q2 next year, in two years’ time etc.
  • Being financially settled and cleared through exchanges means parties to the contract can gain exposure to the freight market whilst minimising counterparty credit risks.
  • It is a simple process to reverse a hedging decision. If an FFA contract has been sold, for example, and circumstances change and the hedge is no longer required, the contract can be bought back.

The above example relates to those FFA contracts dealing with timecharters ($/day) but they can also relate to metric tons ($/ton) or Worldscale, and also price per container box.

 

FFA Contract Parameters:

An FFA contract must be clear on the following five parameters, which will be shown on the Trade Confirmation Note following a trade:

Market:

What is the actual product traded? For Baltic FFA products this will correspond to the route or basket of routes required. For example, on Dry, perhaps a Cape 5TC basket, or the individual C5 route. Likewise for a Dirty Tanker route, it will need to specify if, say, a TD3C or perhaps a TD20, and so on, for whichever Baltic FFA is traded.

Most liquidity is found in the TC baskets and as such they are more frequently traded than the individual routes.

The trade confirmation note from a broker will specify which FFA product was traded.

Period:

The FFA market is traded in days (usually multiples of 5 days), months (equivalent to 30 days), quarters (3 months), and calendars (12 months). Strips may also be traded, for example, Feb/Mar/Apr or Cal 25/26/27 etc. The Tanker FFA products also allow for trading of the balance of the current month, known as Balmo.

It is important to note the user is not trading specific dates within that contract. If, for example, a vessel laycan has dates 05-25 March, the user could look to trade the numerical equivalent of the voyage duration (usually in multiples of 5 days) from the March contract.

The trade confirmation note from the broker will specify the size (number of days/lots) of the trade.

Volume:

Being a flexible contract, it is possible to trade in multiple days (or mt or boxes) for the same month, quarter or year – for example, buying or selling 60 days of a March contract, or buying or selling a portion of the same, for example, 45 days of a Q4 contract rather than the full 90 days.

The trade confirmation note from the broker will specify the size (number of days/lots/boxes) of the trade.

Price:

The trade confirmation note from the broker will specify the price the FFA was bought/sold at.

Exchange:

Four exchanges clear FFA trades: CME, EEX, ICE and SGX. It is important to clarify which exchange the trade will be given up to.

The trade confirmation note from the broker will specify the chosen Clearing Exchange.