Lesson 24 of 25 · 7 min

A base-metal market, 2022: a short position and a suspended market

A short's loss has no ceiling, and the venue that prices it can also stop pricing it altogether.

In March 2022 the price of nickel rose from a level reported at around thirty thousand dollars a tonne to briefly above one hundred thousand dollars on 8 March 2022, a move reported at roughly two hundred and fifty percent over two sessions. A large producer held a very substantial short futures position, together with over-the-counter positions written with several banks, against its own physical output.

As a hedge against physical production that is a coherent structure, and it fails in the same way as the 1993 episode in lesson 5. The short futures position settles in cash daily; the physical metal in the ground, in process, or in a warehouse does not. A rising price therefore produces immediate margin obligations against an offsetting gain that cannot be monetised on the same timetable.

Two features specific to a short compounded it. The loss on a short has no upper bound, because there is no ceiling on a price. And the margin requirement is a percentage of the current value, so it rises with the price as well, meaning the cash demand grows faster than the loss alone.

Then the venue acted. On 8 March 2022 the exchange suspended trading in the contract and cancelled several hours of trades executed that morning, reopening later with daily price limits. Legal proceedings followed the cancellation. The mechanism to take away is that a market price is a settleable fact only while the venue is operating, and the rules under which it operates include the power to stop.

A futures position is a contract with a venue as well as with a counterparty. The venue's rulebook is part of your position, including the parts about suspension.

Key terms

Unbounded loss: The property of a short position that there is no maximum price, so there is no maximum loss and no worst case to size collateral against.
Physical hedge: A derivative position offsetting the price risk of inventory or production. Correct on price and mismatched on cash, because only one leg settles daily.
Trade cancellation: A venue voiding executed trades under its rules. It reassigns outcomes between the two sides of every cancelled trade, after the fact.

Worked example

What a rising price demands from a short

Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A short of 5,400 tonnes at $29,400 a tonne at an 11 percent initial margin, when the price reaches $48,200.

Value of the short at entry: $158,760,000
Initial margin posted: $17,463,600
Loss at $48,200: $101,520,000
Margin now required: $28,630,800
Total cash to be found: $112,687,200
Offsetting gain on the physical metal: $101,520,000, unrealised

The hedge was exact and the cash demand was $112,687,200 against nothing realisable. The requirement grew with the price, which is the feature that makes a short different from a long.

Check yourself

A producer is short 1,200 tonnes at $26,800 with initial margin of 12 percent. The price reaches $41,500. How much cash is required in total?

Saved in this browser only. No account, nothing sent anywhere.

Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.