An FFA comes up when a ship operator wants to see its hiring costs for the coming months, or a shipowner wants to see its future ship revenue, by fixing freight on an index.

Baltic Exchange freight indices

A freight index expresses the cost of moving cargo by sea as a number, by route and vessel type. The underlying asset of a forward freight agreement (FFA) is this index.

In 1985, the Baltic Exchange began producing independent freight prices with the backing of shipping brokers. The exchange treats a group of brokers who stand between shipowners and charterers (the parties who hire ships) as a "panel," collects the freight level for each route from the panel, takes a weighted average, and publishes the result every day as an index. Indices exist for the dry bulk, tanker, and container sectors. The dry bulk indices include the Baltic Dry Index (BDI, 1985) and the Panamax Index (BPI, 1998). They also include the Capesize Index (BCI, introduced in 1999 and revised in May 2014) and the Supramax Index (BSI, 2005). Indices for individual routes, and indices that combine routes, serve as the underlying of freight derivatives1.

How an index is quoted depends on the vessel type. Dry bulk futures quote freight in dollars per day, and tanker futures in dollars per ton2. In dry bulk, there are indices that take a weighted average of freight worldwide by vessel size3. They are averages of time charter rates (the rate for hiring a ship for a set period), published for each vessel class such as Capesize and Panamax4. The Capesize index is published under the name "5TC"4. As of a 2018 paper, trading was concentrated in longer quarterly or calendar-year contracts settled on these average indices3.

The contract rate versus the index average

An FFA fixes, by contract, the freight rate for a chosen route and vessel type over a specified future period. It is a contract between two parties that is cash-settled, with no delivery of ships or cargo5.

Consider a hypothetical example in which Company B, a ship operator, plans to hire a Capesize vessel at the market rate for 30 days next month. Because Company B's costs rise when freight rates rise, it buys an FFA and fixes the rate at USD 20,000 per day. The seller is a shipowner whose revenue falls when freight rates fall. CME's freight futures also settle on Baltic Exchange indices4.

Term Value
Index Capesize freight index (dollars per day)
Contract rate USD 20,000 per day
Settlement period Business days next month (days on which the index is published)
Number of days 30 (30 lots, taking one day as one lot)

During the settlement period, the index is published every day. The settlement amount is the difference between the arithmetic average of the index published over the settlement period and the contract rate, multiplied by the number of days. For the comparable contract that CME listed, the settlement price was defined as the arithmetic average of the index published on each business day of the period4.

Company BBuyerClearingSellerOwner etc.Gets (up)Pays (down)Pays (up)Gets (down)
Figure 1Flow of a trade in which Company B buys an FFA
Figure description

Company B and the seller hold the FFA through a clearing house. If the average index over the settlement period is above the contract rate of USD 20,000 per day, Company B receives the difference multiplied by the number of days, and the seller pays the same amount. If the average is below USD 20,000 per day, the direction reverses: Company B pays and the seller receives. No ship or cargo moves.

The figure shows the cleared case. An FFA was originally an OTC derivative, concluded by two parties through a broker6. The difference between a cleared FFA and a time charter is covered in the section "Basis, credit risk, and thin trading."

Gains and losses when the index average moves

The buyer's gain or loss on an FFA depends on how far the average index over the settlement period is from the contract rate. Per day, the buyer's result is the average index minus USD 20,000, and the seller's result has the opposite sign.

−10,000−5,0000+5,000+10,00020,000Profit/loss (dollars per day)Average index over the settlement period (dollars per day)ProfitLossBreakeven 20,000
Figure 2Buyer's gain or loss per day on an FFA (contract rate USD 20,000 per day)
Figure description

This is the gain or loss per day for a buyer of an FFA at a contract rate of USD 20,000 per day. At an average index of USD 20,000 per day the result is 0, the break-even point. Each dollar the average rises adds one dollar to the buyer's result, reaching a gain of USD 6,000 at USD 26,000 per day. Each dollar it falls subtracts one dollar, reaching a loss of USD 6,000 at USD 14,000 per day. Unlike an option, the gain has no cap. If the index average falls to 0, the loss is USD 20,000 per day.

For 30 days, multiply by 30. The table below assumes that the cost of hiring the vessel equals the average index and shows the result combined with the FFA (signs are from Company B's point of view, with payments shown as negative).

Average index over the settlement period (dollars per day) Cost of hiring the vessel (dollars) FFA payment or receipt (dollars) Total (dollars)
26,000 −780,000 180,000 −600,000
20,000 −600,000 0 −600,000
14,000 −420,000 −180,000 −600,000

If freight rises to USD 26,000 per day, Company B's cost increases to USD 780,000, but it receives USD 180,000 on the FFA, so the total is USD 600,000. If freight falls to USD 14,000 per day, the cost falls to USD 420,000, but it pays USD 180,000 on the FFA, so the total is the same USD 600,000. Company B also gives up the gain when freight falls.

This table is the simple case in which the cost of hiring equals the index. Actual freight on a vessel may not match the index, and that gap is covered in the section "Basis, credit risk, and thin trading."

Vessel types and contract units

Freight indices exist by vessel type and route, so FFAs also divide into different contracts depending on which index they settle on. The specifications of freight futures that exchanges have listed show the difference between dry bulk and tankers.

Contract (CME) Index Unit Size of one lot
Dry bulk (Capesize 5TC; delisted in 2017) Baltic Exchange Capesize 5TC (average of time charter rates) Dollars and cents per day 1 day
Tanker route TC7 Cargo of 35,000 metric tons from Singapore to the east coast of Australia Dollars and cents per metric ton 1,000 metric tons
Tanker route TD19 Cargo of 80,000 metric tons from Ceyhan to Lavera within the Mediterranean Dollars and cents per metric ton 1,000 metric tons

The Capesize contract is one day of freight per lot, and its settlement price is the arithmetic average of the index published on each business day of the period. CME had listed four dry bulk freight futures, including this contract, and their delisting was filed in June 2017. The filing states that these contracts had no open interest and that there would be no market disruption. The filing does not give the reason for the delisting4.

The tanker route futures are the ones that CME filed in January 2020, stating that they would be listed in February. The settlement price is the average of the freight published on each day of the period. Each day's freight is the Worldscale points multiplied by that day's flat rate, converted into dollars and cents per metric ton7.

Uses, and how an FFA differs from a time charter

A change in freight is a change in cost for a charterer who hires ships and a change in revenue for a shipowner who lets them. The 2025 paper says that shipowners and charterers alike look for ways to reduce freight rate risk, and that freight derivatives are the tool for it8. Both time charters and FFAs are used by shipowners and charterers to manage freight rate risk9.

A shipowner who sells an FFA receives on the FFA the amount by which ship revenue falls when freight falls, and pays on the FFA the amount by which revenue rises when freight rises. The shipowner gives up the extra revenue when freight rises in exchange for limiting the lost revenue when it falls. In both cases, this describes using the FFA to fix freight and so lock in costs or revenue, not to bet on the direction of the index. For example, a party whose costs or revenue do not move with freight would see its gain or loss depend only on the index. The general idea of hedging is covered in How Corporates Use Derivatives.

Besides an FFA, a time charter is another way to fix freight for a set period. The 2018 paper's comparison of the two is as follows10.

Item FFA Time charter
Nature of the contract A financial contract that settles only the difference between the index and the contract rate A physical contract that gives commercial management of a ship and the use of its transport
Securing a ship or transport Not possible Possible
Counterparty default Almost none if cleared Exists for each charterer
Difference from the index Determined by the index for a standard ship The vessel specification, route, and period are the actual ones

Over the same period in dry bulk, time charter rates are often higher than FFA prices. The paper points to two explanations for this premium, compensation for default risk and the value of securing transport, and says the two generally cannot be separated empirically10.

Weather derivatives are also alike in that they are cash-settled on an index of something that cannot be delivered. A freight index differs from a weather index, which is built from observations, in that the exchange builds it from values collected from shipping brokers1.

Basis, credit risk, and thin trading

What an FFA cash-settles is the difference from the index, not the difference from the freight Company B actually pays. This gap is the basis behind basis risk. The 2018 paper lists four causes of differences between the cash flows on an actual ship's freight and on an FFA. The first is that the actual ship's specification differs from the index's standard ship. The second is that the actual ship's route or way of operating differs. The third is that, in a time charter, the default risk of a single charterer is higher than that of the clearing house behind an FFA. The fourth is that the start and end dates of the contract differ, and extension options may be attached11.

Counterparty credit risk differs between a cleared FFA and a time charter. A cleared FFA carries almost no default risk12, while a time charter, which is a bilateral contract, carries default risk1012. The general mechanism of clearing, and the credit risk of bilateral trades, are covered in Cleared vs Bilateral Trades.

Freight cannot be stored as a physical good. In the prior research the 2018 paper cites, FFA hedging is far less effective than in other commodity or financial markets. The paper says this is typically attributed to freight being non-storable, so that there is no cost-of-carry relationship between current freight and future freight13.

The other risk is thin trading. As of the 2018 paper, contracts for individual routes had stopped being traded, and trading had concentrated in longer contracts3. A contract for the route or period you want to use may not be easy to buy or sell right away.

Trading venues and freight options

FFAs began in the early 1990s as over-the-counter trades. They are contracts between two parties, with brokers arranging the trades6.

CME's January 2020 filing says that it would list tanker freight futures for trading on CME Globex and for submission for clearing through CME ClearPort. The filing states that the CME Clearing House would clear them and that the minimum size of a block trade is 5 lots (5,000 metric tons), set to match over-the-counter market convention14.

Freight options are contracts close to ordinary options, written on the difference between the current level of freight and a strike price15.

Notes

  1. Papayiannis, "Static hedging of freight rate risk in the shipping market under model uncertainty" (arXiv, second version, April 2025), page 4 (section 2.1: 1985, the panel, the weighted average, daily publication, sectors, the underlying, the year each index began). ↩ ↩2

  2. Papayiannis (same), page 2 (introduction: "dry bulk futures are contracts quoted in USD per day while tanker freight futures are quoted on USD per ton"). ↩

  3. Adland and Alizadeh, "Explaining price differences between physical and derivative freight contracts" (Transportation Research Part E, vol. 118, 2018), page 3 (introduction: weighted-average indices of freight worldwide, and the longer quarterly or calendar-year contracts settled on that average index). ↩ ↩2 ↩3

  4. New York Mercantile Exchange, "NYMEX Submission No. 17-251" (June 2017), Appendix A, Chapter 769 (769101, 769102.B, C, and E) and the main text (the four contracts to be delisted). ↩ ↩2 ↩3 ↩4 ↩5

  5. Adland and Alizadeh (same), page 2, footnote 1 (definition of an FFA: "cash-settled contract between two counterparties"). ↩

  6. Papayiannis (same), page 2 (introduction: "over the counter (OTC) through broker agencies") and page 4 ("introduced in early 90's as over-the-counter (OTC) derivatives contracts"). ↩ ↩2

  7. New York Mercantile Exchange, "NYMEX Submission No. 20-007 (1 of 2)" (January 2020), the table in the main text (specifications of TC7 and TD19) and Exhibit A, Chapters 673 and 674 (101 Floating Price). ↩

  8. Papayiannis (same), page 2 (introduction: "shipowners and the charterers", "freight derivatives"). ↩

  9. Adland and Alizadeh (same), page 2 (introduction: "both period and FFA contracts are used for managing spot freight rate exposure by shipowners and charterers"). ↩

  10. Adland and Alizadeh (same), the abstract ("TC rates are generally priced higher than FFAs") and page 3 (introduction: the explanation of the differences between a time charter and an FFA). ↩ ↩2 ↩3

  11. Adland and Alizadeh (same), page 3 (introduction: items a to d of "multiple potential sources of cash flow differences (basis risks)"). ↩

  12. Adland and Alizadeh (same), page 2 (introduction: "virtually no default risk when they are cleared"). ↩ ↩2

  13. Adland and Alizadeh (same), pages 2 to 3 (introduction: the prior research on weaker hedging effectiveness, and the attribution of the reason). ↩

  14. NYMEX 20-007 (same source as cme-tc7 above), the main text (venues; the minimum size of a block trade) and the Core Principles, Financial Integrity of Contract. ↩

  15. Papayiannis (same), page 2 (introduction: "Freight options are contracts very similar to vanilla options and are written on the difference of the freight rate spot price from a specified strike price"). ↩