How Physical Commodity Traders Hedge Their Positions

Physical trading is not a guessing game. Prices move while cargo is on the water, and one bad swing can wipe a margin. Hedging locks in economics so you make money from logistics, basis, and execution rather than betting on direction. Finance jargon stays in, and every term is translated to plain English right after.

The Role of Exchanges and Where the Hedge Lives

London Metal Exchange (LME)

Global benchmark for industrial metals such as copper, aluminium, zinc, nickel, lead, and tin. Contracts settle on daily, weekly, and monthly prompt dates, which match shipment calendars well.
Plain English: dates line up with your laycans and arrival windows, so you can short or long the exact month you need.

CME Group (COMEX, NYMEX, CBOT)

Metals like COMEX copper and precious, energy like WTI and gas, and grains like corn and soybeans. U.S. centric benchmarks with deep liquidity.
Plain English: if your pricing or customers are U.S. based, CME is often the cleanest proxy.

Arbitrage and Cross-Exchange Hedging

The same commodity can price differently across LME, CME, SHFE, DCE, or ICE because of taxes, freight, FX, or delivery rules. Traders can lift risk and sometimes earn extra by working those gaps.
Plain English: buy where it is cheap, sell where it is rich, and keep the hedge where liquidity is best for the delivery point.

• Example: COMEX copper trades at a premium to LME. A trader buys LME-linked physical, sells COMEX futures, and delivers into a U.S. price. The futures spread locks the price gap.
• Other venues: ICE for Brent and softs, SHFE for China metals, DCE for iron ore and soymeal.

The Five Classic Hedging Techniques

1) Short Hedge (Sell Futures)

In jargon: sell futures to protect the value of metal you own or will receive.
Plain English: you already have copper coming; if prices fall, your short futures gain offsets the physical loss.

Worked example: physical buy 5,000 t copper at 8,800 per t. Hedge by selling 200 LME lots of copper (25 t per lot) at 8,820. If spot later is 8,500, physical P&L is −300/t, futures P&L is +300/t. Net before costs is flat, your spread and logistics margin survive.

2) Long Hedge (Buy Futures)

In jargon: buy futures to cap the cost of metal you must purchase later.
Plain English: you will need wheat in two months; buy futures now to lock cost. If price jumps, the futures gain pays the extra cash price.

3) Back-to-Back Physical

In jargon: match a physical purchase and sale in volume, spec, and timing to remove outright price risk.
Plain English: fix both sides early and keep the margin from the spread after freight and fees.

• Buy 25,000 t coal FOB at 150 and sell CIF at 165. Freight 10. Margin is 5 regardless of flat price moves.

4) Options (Calls and Puts)

In jargon: buy a put to floor a sale price or buy a call to cap a purchase cost. Sell options to collect premium when you can carry the risk.
Plain English: this is insurance. You pay a premium for the right to trade at a fixed level. Use it if the market hurts you and ignore it if the market helps you.

5) Basis Trading

In jargon: hedge the futures leg and manage the basis between your local cash market and the exchange price.
Plain English: futures cover the global price; you focus on the local discount or premium. That basis is where traders often earn edge.

P&L Mechanics You Actually Feel

A Simple Hedge Walkthrough

1. Map the exposure: 5,000 t copper, 3-month delivery, pricing on arrival, sales to Asia basis CIF.
2. Choose the proxy: LME copper 3-month is the cleanest instrument for this flow.
3. Size the hedge: copper lot is 25 t per LME lot. Hedge 200 lots to cover 5,000 t.
4. Execute and document: sell futures, book the physical, record both with timestamps and trade tickets.
5. Mark and roll: track daily P&L, adjust for shipment slips, and roll to new prompts as needed.
6. Lift the hedge: when the physical is priced and sold, buy back the futures and book the basis result.

Options Structures That Traders Actually Use

• Protective put: producer floors revenue while staying open to upside. Cost is the premium.
• Collar: buy a put and sell a call to reduce or eliminate net premium. Caps upside, floors downside.
• Call spread for consumers: cap purchase cost with lower premium than an outright call.
• Zero-premium ideas: only when the sold option risk is acceptable inside limits. No free lunch.

Operational Controls That Keep You Out of Trouble

• Daily reconciliation: physical vs paper position by product, location, and month.
• Hard limits: VaR, stop-loss, max prompt month exposure, and counterparty caps.
• Two-person rule: trade entry and confirmation by separate people. No side channels.
• Clearing and margin lines: pre-agree with brokers. Stress test cash calls.
• EFP/EFS procedures: documented steps for exchange for physical or swaps where relevant.

Quick Reference

• LME lot sizes: copper 25 t, aluminium 25 t, zinc 25 t, nickel 6 t. Know your lots before you hedge.
• COMEX copper lot: 25,000 lb (≈11.34 t). Cross-hedges require correct conversion and correlation checks.
• Carry math matters: interest + storage − convenience yield. This is why contango and backwardation exist.
• Basis is a P&L engine. Track it by location and quality, not just by headline price.

This article is for professional audiences. Hedging involves margin calls and market risk. Always set documented limits, confirmations, and clearing arrangements before taking positions.