Many of you are aware SMU is trying to get better educated about the CME/NYMEX hot rolled futures contract. We have a number of members who are active participants in the futures market for various reasons – most related to hedging but there could be a speculator or two amongst them as well. One important difference between hot rolled futures and other “metals” is the CME/NYMEX is based on an index settlement and not on actual physical delivery of a hot rolled coil.

Here is an email received from one of our members who is actively involved in the hot rolled futures contract market as well as with other metals:

“As you know the CME HRC contract index is provided by CRU. It seems to me that the CRU index sorely lags the market by often several weeks or more. I don’t really understand their methodology of how they collect their data.

The CME contract nonetheless continues to have solid interest – mostly from financial institutions and corporate hedgers at large manufacturers (i.e. buyers of HRC). Steel mills (i.e. sellers of HRC) have not really adopted the contract…but it is not really necessary that they do. As you can see from the below link, current Open Interest is 9516 lots or 190,320 tons (20 tons per lot). That is a pretty good Open Interest. If you estimate $550 per ton on average X 190,320 = $104,676,000. So in other words the value of all of the open HRC steel contracts on CME is over $100 million dollars. That is a little more than chump change!

http://www.cmegroup.com/trading/metals/ferrous/hrc-steel_quotes_settlements_futures.html

Copper, Zinc and Aluminum are all physically settled and therefore are not at the mercy of index pricing like HRC. I do not know of any other metals that are index settled.”

The author of the above email told SMU during the past week 9,800 tons (or 490 twenty ton contracts) changed hands.

SMU went to a seminar on the HR Futures Contract market which was conducted by Jonathan Putman of the Birmingham Futures Exchange. One of the things we learned is the cost to trade one contract (20 tons) is $660 or $33 per ton. The individual who wrote the email to SMU above had this to say about the cost to play:

“$660 per lot is the initial margin required to buy or sell a lot of steel on CME – think of it as a down-payment. Or in poker terms the ante. If the market moves against your position you would still be required to post variation margin dollar-for-dollar to cover the adverse market move.”

SMU is slowly building an understanding of the hot rolled futures contract as we believe it can be a helpful tool to those who wish to hedge (protect their original investment or profit) against swings in market pricing.

Many of those in the financial community appreciate SMU index capability because we tend to be closer to “real time” and we mark the trends and momentum in pricing. This is not something we planned to do (to assist the financial community) but is a result of our ties within the steel buying community. We will let you be the judge of the value of our indexes as time goes by.

The above article appeared in the December 23, 2009 issue of our Steel Market Update newsletter. Shortly after being published we received comments from the Birmingham Futures Exchange which has been one of the companies helping SMU understand the workings of the HR Futures market. Here are the comments they had regarding the above article:

Please let me clarify something in your December 22nd issue of SMU.

Your reader wrote:

“$660 per lot is the initial margin required to buy or sell a lot of steel on CME – think of it as a down-payment. Or in poker terms the ante. If the market moves against your position you would still be required to post variation margin dollar-for-dollar to cover the adverse market move.”

A better metaphor might be to compare the initial margin requirement of a steel futures contract to a damage deposit you put up to rent a condo at the beach. When the contract settles you get the entire deposit back, less any charge for damages. Damages result when the market moves against you. You normally pay those charges by covering your margin call, leaving your original deposit intact.

The minimum margin requirements are set by the futures exchange on which the contract trades. This can be changed from time to time at their discretion. The clearing firm that handles the trade may require additional margin but never less than the minimum. Hedgers (those who have a position in the physical product, i.e. steel users) are currently required to post $600 per contract ($30/ton) while speculators must post $660 ($33/ton).

The current rates can be found under NYMEX METALS at http://www.cmegroup.com/wrappedpages/clearing/pbrates/performancebond.html .