Guide to LME Trading & Market Data
The LME provides the flexibility of three trading platforms, which operate side-by-side:
1145 to 1700 hours, London Time
Open-outcry is the oldest and most popular way of trading on the Exchange. It is central to the process of .price discovery., a term used to describe the way LME official prices are established. These prices are derived from the most liquid periods of trading; the short open-outcry .ring. trading sessions, and are most representative of industry supply and demand. The official settlement price, on which contracts are settled, is determined by the last offer price before the bell is sounded to mark the end of the official ring.
0100 to 1900 hours, London Time
LME Select is the official Exchange-operated electronic trading platform. LME member firms are connected to the LME Select system which allows accredited traders to execute trades electronically. It allows for straight-through processing in which LME Select trades are automatically sent to the matching and clearing systems operated by LCH.Clearnet.
The system also enables LME members to connect their clients directly to the LME Select trading system via third party applications, a process known as .order-routing..
24 hours a day
The Exchange also supports an inter-office telephone market between LME members which operates 24 hours a day.
The LME's forward contracts allow producers, fabricators, merchants and consumers to insure against price risk.
The LME also offers traded options contracts based on each of these futures contracts, together with traded average price options contracts (TAPOs) based on the monthly average settlement price (MASP) for all metals futures contracts.
All LME prices are quoted in US Dollars, but the LME permits contracts in sterling, Japanese yen, and Euros and provides official exchange rates from US Dollars for each of them.
Trade is conducted in lots rather than tonnes, with each lot of aluminium, copper, lead and zinc amounting to 25 tonnes. Nickel is traded in 6 tonne lots, tin in 5 tonnes and aluminium alloy and NASAAC in 20 tonne lots. PP and LL are traded in 24.75 tonne lots.
The contract for each metal sets out the shapes, weights and methods of strapping (metals) and packaging (plastics). The contract specifications are for the quality and shape which are most widely traded and demanded by industry.
Futures contracts are purchases or sales of goods for a specified delivery date in the future at prices established today.
Option contracts give trade hedgers and investors a flexible alternative to futures as a means of trading on the Exchange.
TAPO's are Exchange cleared contracts based on the LME Monthly Average Settlement Price (MASP).
Inter-office telephone trading - available 24 hours a day.
LME Select - available from 01.00 - 19.00 (London time).
Ring trading - available from 11.40 - 17.00 (London time). Times as follows:
Steel FF and FM 11.40 to 11.45
Aluminum Alloy & NASAAC 11.45 to 11.50
Tin 11.50 to 11.55
Primary Aluminum 11.55 to 12.00
Copper 12.00 to 12.05
Lead 12.05 to 12.10
Zinc 12.10 to 12.15
Nickel 12.15 to 12.20
Plastics LL, LA, LE, LN 12.20 to 12.22
Interval 12.22 to 12.23
Plastics PP, PA, PE, PN 12.23 to 12.25
Interval 12.25 to 12.30
Copper 12.30 to 12.35
Aluminum Alloy & NASAAC 12.35 to 12.40
Tin 12.40 to 12.45
Lead 12.45 to 12.50
Zinc 12.50 to 12.55
Primary Aluminum 12.55 to 13.00
Nickel 13.00 to 13.05
Steel FF and FM 13.05 to 13.10
Interval 13.10 to 13.20
Kerb Trading 13.20 to 14.45
Interval 14.45 to 14.55
Aluminum Alloy & NASAAC 14.55 to 15.00
Lead 15.00 to 15.05
Zinc 15.05 to 15.10
Copper 15.10 to 15.15
Primary Aluminum 15.15 to 15.20
Tin 15.20 to 15.25
Nickel 15.25 to 15.30
Steel FF and FM 15.30 to 15.35
Plastics LL, LA, LE, LN 15.35 to 15.37
Interval 15.37 to 15.38
Plastics PP, PA, PE, PN 15.38 to 15.40
Lead 15.40 to 15.45
Zinc 15.45 to 15.50
Copper 15.50 to 15.55
Primary Aluminum 15.55 to 16.00
Tin 16.00 to 16.05
Nickel 16.05 to 16.10
Aluminum Alloy & NASAAC 16.10 to 16.15
Kerb Trading 16.15 to 17.00*
at 16.35 Tin, PP and LL cease trading;
at 16.40 Lead and Steel ceases trading;
at 16.45 Nickel ceases trading;
at 16.50 Zinc ceases trading;
at 16.55 Copper ceases trading;
at 17.00 Primary Aluminum, Aluminum Alloy and NASAAC cease trading
The LME is a 24-hour market with trading taking place through an inter-office telephone market and LME Select, an electronic trading platform. The LME is most famous for its open-outcry trading between ring dealing members, which takes place on the market floor.
Each day the LME announces a set of official prices, which are determined from the open-outcry trading. This trading is highly liquid and trade and industry has confidence that they properly reflect the current supply/demand situation.
These prices are used by industry worldwide as the basis for contracts for the movement of physical material throughout the production cycle.
Price discovery is one of the most important functions of the Exchange. The most reliable prices in any market are derived from those where the greatest concentration of trading takes place. While trade can take place at any time on the LME because of its flexibility, the greatest concentration for each contract occurs during the five minute ring sessions, especially the second ring session.
At the end of each five minute ring (in the second ring session) the LME market operations staff, who monitor ring trading from the ring itself, determine the official prices from the last bid and offer for cash, three months and fifteen months before the bell is sounded to end the ring.
These prices become the settlement prices (that is, the cash seller's price) so long as they result from trading in the ring which meets all the LME standards. The ring prices are highly transparent, and are sent around the world almost instantaneously. Market participants are able to judge immediately that the prices properly reflect supply and demand at that time, and have great confidence in the result.
Other prices in the forward curve are determined using trades as well as established formulae - this is important as not every date available might be traded on each business day.
The Exchange also determines "unofficial" prices from the fourth ring in a similar way to the official prices.They are used as a further benchmark and are helpful where there have been significant price movements between the second ring and close of floor trading.
One further set of prices in important to note. These are the closing prices, derived from the final kerb session of the day. These are important for market participants as LCH.Clearnet uses them when it determines margin requirements at the close of business.
Through its trading members, the LME offers those at all stages of the metals or plastics supply chain, including both buyers and sellers, the opportunity to hedge their material price risk, and therefore gain protection from future adverse price movements.
Hedging is the process of offsetting the risk of price movements in the physical market by locking-in a price for the same commodity in the futures market. The reasons for doing this are clear: for a converter, for example, it allows for better control of their raw material costs and for a producer, better management of product pricing.
There are predominantly two motivations for a company to hedge:
- To lock-in a future price which is attractive, relative to an organization.s costs
- To secure a commodity price fixed against an external contract
When hedging, an organization starts with price risk exposure from its physical operations, and will buy or sell a futures contract to offset that price exposure in the futures market. The ability to hedge means that an organization can decide on the amount of risk it is prepared to accept. It may wish to eliminate price risk entirely and it can generally do so quickly and easily on the LME.
Hedging by trade and industry is the opposite of speculation as its primary purpose is to offset risk. Speculators, however, come to the futures market with no initial risk; they assume risk by taking futures positions. Hedgers reduce or eliminate the chance of future losses or profits, while speculators risk losses in order to make profits.
To be successful, a hedging program must be devised in conjunction with a sale or purchase plan, and all pricing must be basis the LME settlement price in order to achieve the most effective hedge and to meet the requirements for international accounting standards. The program can be as simple or as complex as a company wants to make it, but it will be unique depending on that company.s appetite for risk, internal practices, pricing policies and hedging motives. Not only must a hedging program be well devised, but it must also be managed continuously in line with the changing circumstances of a company.s physical operations.
Hedging in practice
This example provides an overview of a typical offset hedge strategy conducted on the LME. An offset hedge is designed to remove the basis price risk of the physical operation by offsetting it with an equal and opposite sale or purchase of a futures contract on the Exchange. Any risk of price volatility that has arisen from the physical transaction is thereby eliminated.
An offset hedge is a financial operation in which the hedger (the company hedging) maintains a .balanced book., with each physical transaction being offset by an LME transaction. In this example, both the buyer and the seller choose to hedge their price risk. However, it is not necessary for both parties to the physical transaction to hedge; this will depend entirely on their organisation.s internal practices and approach to risk management.
There are three main stages to the process:
1. Physical Transaction
A producer agrees to sell a specific quantity of physical material to a consumer for a delivery date in the future. For hedging to be successful for either party, the contract must be agreed basis the current LME price*.
Due to the future delivery aspect, both the producer and the consumer are likely to be exposed to a change in price over the period of the physical contract. Each company has the ability to hedge this exposure on the LME.
2. Financial Transaction
Once the physical transaction has been agreed, the hedger will instruct its broker to open up a futures contract on the LME. This will be made up of an equal and opposite position for the same delivery date as their physical transaction. In doing this, the hedger will have locked-in the future price and delivery date to match the physical contract already agreed.
Once a contract, or trade, on the Exchange has been entered and matched by the broker, a process known as .novation. takes place. This is when the clearing house, LCH.Clearnet, becomes the counterparty to both sides of the trade. The brokers are now no longer exposed to the credit worthiness of each other and the financial risk of default is carried by the clearing house.
When entering into a futures contract a hedger will be required to make margin payments to their broker, both an initial margin at the outset, and variation margin throughout the life of the contract. Variation margins are a form of collateral which provide daily security against any adverse price movements of a futures position. Margins are a regulatory requirement and are calculated by LCH.Clearnet, not the broker.
Two days before the delivery date, the hedger will instruct its broker to financially settle the LME position by buying or selling back the original futures contract at the current LME settlement price.
Working in parallel to the financial transaction, the producer makes the physical sale of material to the consumer, as agreed at the outset. Providing that this is agreed basis the current LME settlement price, the price risk of the base product over the period for both parties will have been eliminated, as the profits from one transaction will offset losses from the other, and vice versa.
*LME contract specifications are for benchmark specifications/grades of material, and it is therefore likely that the producer will add additional premiums for additives etc. However, the only part of the price that can be hedged via the LME is the benchmark specification/grade portion.
Warehousing and physical delivery
As a market of .last resort., industry can use the LME.s delivery option to sell excess stock in times of over supply and as a source of material in times of extreme shortage. To support this mechanism the Exchange approves and licenses a network of warehouses around the world.
LME approved delivery locations are typically located in areas of high consumption or a natural trading hub for the shipment of material. Warehouse companies themselves must also meet strict criteria before they are approved for the handling of metals and plastics. The LME.s daily stock reports play a major part in the assessment of prices quoted by market makers.
In reality, physical delivery occurs in a very small percentage of cases on the LME, less than 1% for its base metal contracts, as most organizations use the Exchange for hedging purposes. However, the small percentage which does result in delivery plays a vital role in creating price convergence. As a delivery date falls due, the LME price will naturally converge with the .spot. or physical price. If there is a discrepancy, some parties will see a favorable opportunity and buy or sell material via the LME system. This has the result of constantly ensuring the LME price is line with the physical market price.