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Spot deferred contracts

Categories Business, Economy, Finance

Essay, Pages 3 (552 words)

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Essay, Pages 3 (552 words)

Introduction

This is like a forward contract with rollover option (find detailed description in chapter. By following this strategy ABX was able to profit from increases in the price of gold and at the same time set a minimum price of gold to protect them if the gold price would fall. Figure 8 depicts roughly the contango for varying rollover dates. Principal characteristics of spot deferred contracts Spot deferred contract Spot deferred contract (SDC) is a forward contract with multiple delivery dates.

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The final delivery date can be up to 10 years after initiation of the contract. The seller has the choice at which of these rollover dates he will deliver and he has the right to defer delivery until the end of the contract.

The beginning of a contract

At the beginning of a contract with 1-year delivery rollover dates, the price to be paid for delivery is set only for the first rollover date. The price is based on the 1-year forward price.

After the 1st period ABX has the following choices comparing the contract price (1-year forward) with the spot price.

  1. Closing: If the spot price is lower than the contract price ABX will deliver and close the contract.
  2. Rollover: If the spot price is higher ABX sells on the spot market and rollovers over the contract for another year.

Thus no money or gold is changing hands. The price for delivering at the next rollover period is set based on the prior contract price plus the prevailing contango premium on the next rollover date.

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Using this instrument ABX could always profit from an increase in the gold price (roll contract over) and on the other hand lock in a minimum price for its production/sales (closing) then.  Profit diagram for ABX if the spot market price is always higher than the forward price x until expiry of contract at S Based on their good financial position and its large reserves in gold ABX could sign agreements with 10-year delivery options.

The spot deferred contract is a mixture of a forward and an option contract because ABX has the right to either close or rollover the contract. If the forward price is at x0 and the spot market price is at x1 then ABX would make a rollover and paying a contango, which is depicted with the dotted line. If the spot market price continuous to raise above the new forward price x2 ABX would again roll over until the expiration of the contract. In this case the profit diagram as shown with the solid line would apply. If the spot market price at any time would be below the forward price ABX would close the contract. In this case ABX would profit from the difference between the forward price and the lower spot market price.

Conclusion

The objective of ABX was to realise a minimum average price of $400 per ounce until 1994. Additionally, if the gold price rose they had the option to sell at higher spot market prices. ABX would be better off if this price difference was bigger than the contango premium to be paid. Compared to other gold derivatives they were able to choose the most profitable solution based on the specific market condition at that time. This increased on average the realized gold price per ounce.

Cite this essay

Spot deferred contracts. (2020, Jun 02). Retrieved from https://studymoose.com/spot-deferred-contracts-13076-new-essay

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