How do freight futures trade?

Freight futures trade primarily off-exchange on a principal to principal basis. Unlike other futures contracts, a centralized trading screen or exchange that market participants can transact does not currently exist. Rather, through a network of brokers, market participants buy and sell freight futures contracts without dedicated market makers. Given the off-exchange structure of the market, there is the ability to transact on a 24-hour basis, although the “normal” trading hours are mainly London hours, from 3am to 12pm EST time. Some trading also takes place during Asian hours, from 11pm to 3am EST time.

In order to buy or sell a freight futures contract, a market participant would contact a freight futures broker and communicate the trading order. The freight futures broker would attempt to find the matching trade, complete the transaction, and submit such transaction to the exchange for clearing thus creating a cleared futures transaction.

How do freight futures clear?

Freight futures clear through exchanges like other futures contracts, and are subject to similar margin requirements like other futures products. Currently, major exchanges provide freight futures clearing, although the most common venues are the European Energy Exchange (EEX), the Intercontinental Exchange (ICE), the CME, and the Singapore Exchange (SGX). Each exchange provides its own rules and its own initial and maintenance margin requirements.

How can I trade freight futures?

Although individual investors have the ability to trade freight futures, it is quite uncommon. The great majority of market participants are institutions with considerable capital and strong balance sheets supporting such trading. In addition, the non-standardized nature of trading and clearing makes it uneconomical for brokers and clearing members to provide easy access to individual investors as the minimum trading requirements are relatively large thus would not allow for adequate economics for brokering firms to serve individual investors.

What are the advantages of freight futures?

Freight futures are the closest an investor could get in when it comes to the actual shipping markets. Prior to the institutionalization of freight futures, one could get access to the real shipping market only by buying a ship, a task that requires significant capital commitment, extensive operations and considerable risk.

Freight futures provide the opportunity to participate in the actual shipping market in the most cost efficient, direct and simple way without all the cumbersome of owning actual ships. In addition, one can benefit from both rising and falling markets, as freight futures can be bought or sold short (ship-owning is generally considered a “long” position in the market).

The nature of shipping can lead to considerable fluctuations in the price of freight over short periods of time. Ships need time to sail to ports and when demand for dry bulk transportation increases, imbalances between available ships and cargo requiring shipping can occur. During such periods, freight prices tend to increase, sometimes significantly, as additional ships take time to sail to port and offer their services. Once the market balance is restored, freight prices eventually return to equilibrium.

Due to the idiosyncratic nature of shipping, dry bulk rates tend to be uncorrelated to other investments, such as equities, fixed income, currencies or other commodities. Supply and demand of ships is the major driver, and although over longer periods of time economic activity is the major driver for shipping demand, during shorter periods, shipping rates rely only on the ship/cargo balance.

Who are the main market participants in Freight Futures trading?

Freight futures are used for hedging, arbitrage or speculation. The main users of freight futures are physical users and providers of freight. Physical users of freight include iron ore, coal and grain producers, oil majors, oil traders, refiners steel mills, coal power plant owners and other commodity producers or raw product manufacturers. In addition, trading houses that have exposure to freight and need to transport physical commodities are also major participants.

On the other hand, providers of freight include ship-owning companies and ship-operating companies. Each of the above groups has different needs and a different approach in the use of freight futures. Financial institutions also participate in the freight futures market: Hedge funds and individual traders use freight futures to speculate, invest or diversify their books. Finally, major banks trade freight futures either on a proprietary basis or for their clients’ accounts.

What is the daily trading volume and the open interest in freight futures?

In 2023, the average daily trading volume in dry bulk freight futures was approximately 12,400 lots per day (one lot represents one day’s worth of hire). The open interest across all dry bulk derivatives (futures and options) contracts stands at about 727,000 lots (as of 3/11/2024). For tankers, the average trading volume in 2023 was approximately 3,400 lots per day (one lots represents 1,000 tons of cargo). Open interest across all tanker derivatives contracts stands at about 145,000 lots (as of 3/1/2024).

Over the last five years, the average trading volume of both dry bulk freight futures and tanker freight futures has been steadily increasing and in fact has doubled during the period.