What Is Hardening?

What Is Hardening?

Let me explain what hardening means in the financial world. It's a term that points to trading conditions where securities prices are climbing while volatility is dropping in a specific market. You'll hear this most often in discussions about commodities futures, but it applies elsewhere too.

Beyond that, in the insurance and banking sectors, hardening describes times when underwriting or lending gets tougher and more stringent.

Key Takeaways

Here's what you need to grasp: In finance, hardening usually means prices are going up with less volatility, especially in commodities trading. It's also used in insurance and lending to describe phases of stricter practices. Often, in banking and insurance, this happens right after financial crises as institutions tighten up to cut risks.

How Hardening Works

In commodities trading, I see a market as hardening when prices keep rising steadily but volatility stays low. For many traders like you, this setup is perfect—it's calm and somewhat predictable, making trades easier.

But if you're a trader betting on big price swings, hardening isn't great news. The drop in volatility reduces the chance of those major moves, which can really hurt if you hold options on those commodities—their value tends to sink when the underlying asset's volatility falls.

Important Note

Remember, while we talk about hardening mostly for commodities futures trading conditions, it also covers strict underwriting or lending in insurance and banking.

How Speculators Impact Volatility

There's a common idea that more speculators in commodities futures drive up price volatility. But some research I've looked at says the opposite—these traders add liquidity that actually stabilizes prices, leading to a hardening effect.

These studies argue that futures markets seem volatile not from price swings alone, but from the high leverage traders use. For instance, stocks might need 50% margin, but futures often go as low as 5% to 10%. That means even tiny price changes can hit leveraged positions hard.

Special Considerations

When we shift to insurance and banking, hardening means something else—it's about ramping up underwriting or lending standards. This often follows a big financial hit, like the 2007-2008 credit crunch.

Institutions tighten up after risky moves, such as those optimistic derivatives and subprime loans before the crisis. Post-crisis, they reset to conservative standards to avoid repeats.

Sure, this shift from risky to safe can cut down on bad policies and loans, but it also makes it tougher for solid borrowers or clients to get credit or insurance. During these hardening periods, you'll hear complaints that the rules are too strict.