(C.) Execution
Having set forth a trading strategy and gathered information on market players, you are ready to execute trades. In fact, you are lucky: the rapid advancement of the SO2 market has substantially shortened the learning curve for new participants. Just a few years into the program, there is a fully developed trading system, free-flowing market information, and healthy volume of transactions. Starting with the most basic of trades—a cash spot market transaction—this section explains the contracting issues you should be aware of as you close a deal and how to report the trade to regulatory authorities.
Spot Market Trades
Immediate settlement trades, or trades made in the spot market, are the most liquid
type of transaction structure in emissions trading markets, accounting for approximately
75% of purchases and sales. Correspondingly, these transactions see daily bids and
offers. Bids are firm commitments to purchase a specific quantity of allowances at a set
price. Offers are the other side of the equation: firm commitments to sell a specific quantity
of allowances at a specific price. Typical cash settlement bids and offers come in 5,000
to 10,000 allowance lot increments, however quantities as low as 1,000 allowances
have been seen, and other than market practicalities, there is no floor to the size of deals.
Before entering the market, it makes sense to assess your needs and set your price parameters relative to the market. If you are short allowances and decide to turn to trading to make up the difference, the compliance planning you executed earlier should provide you with a "buy strategy" that will determine your transaction volume and the price at which you are comfortable buying. Conversely, if your position is long on allowances you will use your compliance planning scenarios to get a sense of how many allowances to offer in the market and at what minimum price you will sell.
Once you have determined your price targets, you are ready to trade. This can be done through a broker or executed bilaterally. No matter which direction you choose, the next step is to communicate your price to the marketplace. Individuals with standing bids and asks are approached first to determine their interest in a purchase or sale of allowances at your price. As interested participants counter with alternative prices, the market is made. From this point forward you can revise your price to move closer to the market and receive another counter bid or offer. This process continues until you have found a price in the market that satisfies your needs.
Having found a price that you are comfortable with, you are ready to lock in and seal the deal. The first step is to give a verbal confirmation or sign a confirmation sheet, which indicates your willingness to lock in the price and begin work on hammering out the contracting details. (Of note: this is also the point at which a broker will reveal the counterparties' identities to each other, should you have decided to go that route.)