Change to BDI looks to boost derivatives trading

The way the Baltic Dry Index (BDI) is calculated will change as of July 1, in a move designed to encourage derivatives trading of the index.

The index will be made up of 25% of the average time-charter rates (dollars per day to hire a vessel) for each of the four vessel types: capesize, panamax, supramax and handysize. The BDI was previously calculated by taking a combination of time-charter rates and voyage rates, which will no longer be used. The new index will have a correlation of 0.99978 to the previous BDI, according to calculations by the Baltic Exchange, which maintains the index.

Jeremy Penn, chief executive of the Baltic Exchange, believes the changes to the index should make it more liquid, and more attractive to the wider audience of mutual funds, hedge funds and traders that he says have showed a growing interest in the BDI recently.

"By re-selecting the index so that it consists entirely of components that are already relatively liquid in the derivatives market, we believe we are making this process considerably easier. It will enable market-makers to offer pricing and hedge resultant positions easily," said Penn.

Duncan Dunn, senior director of business development at the futures department of shipbrokers Simpson, Spence and Young in London, applauded the Baltic Exchange's initiative. "Effectively, the old components of the BDI were individually untradeable. People couldn't make a market in the BDI, they couldn't facilitate anyone investing in the BDI, because there was no way to cover their liability," he explained.

"Now the BDI is composed of four existing tradeable indexes, we hope we can have a forward curve for the BDI, people can have exposure to a derivative of the BDI and anyone who cares to market it, such as a bank, will be able to directly hedge themselves," he remarked.

However, James Leake, London-based managing director of shipping research at interdealer broker Icap, emphasises the change to the BDI will not necessarily help unsophisticated investors seeking to use the index to gain exposure to dry bulk freight. "For that market it's not necessarily going to provide significant demystification. If those investors were interested in how the BDI is calculated, they'd still have to understand the four main vessel sizes and main index routes," he remarks.

"I bet most players active in BDI trading recently probably haven't found out exactly how the BDI is comprised. Quite rightly, they are just using it as a vehicle to speculatively trade 'freight', its precise composition being of marginal relevance," he adds.

See also: Shipping out