What it means
The exchange has a history that goes back to the nineteenth century, and over time it became a centre for commodity trading in New York. It added energy products in the 1970s and 1980s and grew into the home of the benchmark contract for West Texas Intermediate crude oil.
Its metals business, through the COMEX division, covers gold, silver, copper and other metals. A futures contract is a standardised agreement to buy or sell a set quantity of a commodity at a fixed price on a future date.
Most traders never take delivery; they close their positions before expiry by taking an opposite trade. The price discovered on the exchange is published widely and is used as a reference in many physical deals.
Businesses use NYMEX contracts mainly for hedging. An airline worried about rising fuel costs can buy energy futures to lock in a price, while an oil producer worried about falling prices can sell futures to secure its revenue.
Speculators and investors also trade, adding liquidity, which makes it easier for hedgers to find the other side of a trade. Because futures are margined, participants put up a deposit that is a fraction of the contract's value and settle gains and losses every day.
This makes them capital efficient but can lead to sudden cash needs when prices move sharply. Treasury teams that hedge need to plan for those margin calls, and finance directors need to explain to boards that a hedge can show cash outflows even when it is protecting the business as designed.
In 2008 the exchange merged into CME Group, and today most trading takes place electronically through the CME's platforms. The NYMEX name continues to be used for the energy and metals contracts that trade there, and its benchmark prices still appear daily in financial news.
Basis risk is a point that surprises many first-time hedgers. The futures price may not move exactly in line with the price actually paid for the physical commodity, because of differences in location, grade and timing, so a hedge is rarely perfect.
In practice
Real-world examples.
Example
A regional airline expects to burn large amounts of fuel next year and buys energy futures to fix part of its cost. If prices rise, the extra fuel bill is partly offset by gains on the contracts.
Example
A jewellery manufacturer buys gold futures to lock in the price of metal it will need in three months. This protects its margins from a sudden jump in the gold price.
Example
An oil producer sells crude oil futures to secure the price for next quarter's output. If prices fall, the loss on the physical oil is offset by a gain on the futures.
Formula
Calculation
Value of a futures contract = Price per unit x Contract size
For an illustrative crude oil contract covering 1,000 barrels at $80 per barrel, contract value = $80 x 1,000 = $80,000. A $1 move in the price changes the value by $1 x 1,000 = $1,000 per contract. If the exchange requires an illustrative 10% margin, the deposit is $80,000 x 0.10 = $8,000 per contract.Case study
Seen in the real world.
Prairie Haulage is a fictional trucking company that spends about $9,000,000 a year on diesel. After a year when fuel costs jumped by 25% and cut its margins, the finance director decided to hedge part of its fuel purchases using energy futures linked to the New York Mercantile Exchange.
She hedged 50% of expected fuel for the next 12 months and set aside a cash buffer of $400,000 for margin calls. When prices fell in the first quarter, the futures lost money and the company had to post extra margin, which alarmed some board members.
In this illustrative story, the finance director explained that the losses on the futures were offset by lower costs at the pump. Later in the year, prices rose and the hedge protected the budget. The board agreed to keep the programme and to receive a monthly report on hedge positions and margin balances. The treasury team also built a simple model showing the fuel bill with and without the hedge under several price scenarios, which the board found far easier to follow than the contract details.
Watch out
Common mistakes.
- Assuming hedging eliminates all risk. It reduces price risk but introduces new considerations such as margin calls and basis risk.
- Ignoring margin needs. Daily settlement can drain cash even when the hedge is working as intended.
- Confusing the exchange with the benchmark. NYMEX is the exchange, while WTI crude oil is one of the products traded on it.
Questions
People also ask.
What does NYMEX trade?
It trades futures and options on energy products such as crude oil and natural gas, and on metals through its COMEX division.
Who owns NYMEX?
It is part of CME Group, following a merger in 2008.
Do most traders take delivery of the commodity?
No, most close their positions before expiry and settle the gain or loss in cash.
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