Article 5: Trucking Freight Futures – Hedging Strategy, Position Sizing & Trade Execution

Logistics Management and Lakefront Futures’ Trucking & Freight Derivatives Group are currently publishing a series of articles on the “A-Z” of trucking freight futures. This 5th article explains the process of determining what hedging strategies to execute on, which contracts to use, along with position sizing and trade execution.

Previous articles in the series:

• Article 1: The Trucking Paradigm Shift & the New 3-Dimensional Market 
• Article 2: Trucking Freight Futures 101
• Article 3: Hedging Applications for Trucking Carriers, Shippers & 3PLs
• Article 4: Trucking Spot Market Vs. Freight Futures Market Pricing & Price Discovery

Pre-Position Taking Analysis and Vetting

Prior to taking any trucking freight futures hedging positions, a market participant should go through a thorough analysis and due diligence process so that they execute on the optimal hedged position (s) given their trucking rate exposure.    Three important steps in the process are:

Trucking rate risk exposure assessment – In order to determine your trucking rate hedging strategy, it is important to understand the extent of your trucking rate exposure in your active lanes that make up a large percentage of your revenue (carrier, 3PL) or trucking costs (shipper, 3PL).  In that regard, the participant should complete a detailed trucking rate risk exposure analysis where the participant forecasts the expected mileage of what it will haul/ship each month in each of its active lanes for at least the next 6-9 months.  The lanes can then be prioritized based on the level of trucking rate volatility that each of the lanes has experienced in the last 12-36 months.

Correlation study – A trucking rate hedge is only as good as the correlation of the underlying DAT benchmark directional lanes/calculated indices for the trucking freight futures contracts to the actual lanes the market participant is trying to hedge.   For example, if the participant’s active lanes have a rate change twice as much as the underlying DAT directional lane/regional indices benchmark being used, then the participant is going to have significant exposure and a less than ideal hedge.  The participant should compare its active lanes with each of the applicable directional lanes and regional indices and choose the one with highest price correlation.

Position sizing – Position sizing consists of determining how many contracts to trade and in which month.   Obviously, the hedgers expected mileage for each month is a significant aspect given that each contract consists of 1,000 miles. However, the expected revenues or costs together with the impact of seasonality need to be factored into the position sizing analysis.

With the above analysis completed, the participant can determine the best hedging strategy to execute and the optimal position sizing for each trucking freight futures contract.

Hedging Options for Trucking Carriers, Shippers & 3PLs

We are often asked by market participants about what we feel is the best hedging position to take.  There is no cookie-cutter hedge that works for all participants. The best hedging option for a participant depends on the participants objectives, specific trucking rate risk exposure and the ability to monitor its hedged positions. Trucking freight futures provide market participants a variety of ways to hedge their exposure to trucking rate volatility.  In addition, it is not an either/ or decision, as multiple hedging options can be used simultaneously or at different times.

Market participants do not have to hedge their entire trucking rate exposure at one time and instead can incrementally increase their hedged position as trucking rates change.  Furthermore, participants can hedge their overall corporate revenue/trucking costs and/or focus on hedging their trucking rate exposure in each of their active lanes. In between these two primary hedging options, market participants can use a combination of both.   A sampling of a few potential trucking rate hedging options include:

Hedging Corporate Level Revenue or Trucking Costs – instead of hedging specific active lanes, market participants can hedge at a corporate level.  For carriers this means hedging corporate trucking revenue and for shippers this means hedging corporate level trucking costs.  For a corporate level hedge, the participant can use the National US Van futures contract or use 1 or more of the regional futures contracts. Alternatively, they could hedge 50% of the corporate revenue/trucking costs with the National US Van futures contract and use one or more of the regional indices to hedge the remainder of their exposure if their active lanes are concentrated in any region of the country.

Hedging Corporate Revenues via a Stair Stepped Approach - as a  market participant is slowly increasing its hedged corporate revenue position, it can hedge some of its active lanes on an interim basis via futures contracts on the directional lanes and once the participant has fully hedged its corporate revenues it can close out the hedge on its active lanes.

Hedging Active Lanes – Instead of a corporate revenue hedge, a participant can use the various directional lanes or regional futures contracts to hedge their trucking rate exposure in their most active lanes.   An important aspect of this is completing the above-mentioned correlation study of the participants lanes with the best matching DAT directional lanes and regional indices.

Hybrid: Corporate Revenue & Active Lane Hedging – In this option, a participant can partially hedge corporate revenues as a “foundation hedge” – i.e. 40-60% - and can use one or more of the directional lanes or regional freight futures contracts to complete the hedge if the participant is over exposed in a specific region of the country – i.e. West Coast or a specific general lane.

Conclusion

Given the extent of analysis that is required to ensure that the participant is taking positions that will provide an effective hedge, it is recommended that a market participant work with a trucking freight futures advisor that has not only technical futures trading expertise but has the trucking market insight to provide credible guidance on which contracts to use. An advisor may also be able to provide access to a large base of potential counter parties that could be interested in the other side of the trade.

Logistics Management is launching a new section in both its weekly digital and monthly print publications to reflect the new 3-dimensional market – “Trucking & Freight Markets 360o”. This section will provide a comprehensive snapshot of the trucking spot, forward and futures markets along with the diesel/derivatives market. The content will be provided by Gary Saykaly who is the national head of Lakefront Futures’ Trucking & Freight Derivatives Group which helps market participants hedge trucking rate and fuel cost risk – [email protected].

Futures trading involves substantial risk of loss and is not suitable for all investors.