COLUMN-Options are the accelerant for copper's raging bull fire: Andy Home

Options are the accelerant for copper’s raging bull fire

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By Andy Home

LONDON, Dec 1 (Reuters) – Doctor Copper is on fire.

London Metal Exchange (LME) copper hit a year-to-date high of $7,708.50 per tonne on Monday, a level not traded since March 2013. At a current $7,670, the exchange’s benchmark three-month contract CMCU3 is up by 24% on the start of the year and by an extraordinary 75% from the March low of $4,371 per tonne.

Copper bulls can choose from a wealth of positive drivers to justify the rally.

China’s manufacturing recovery from COVID-19 has exceeded all expectations with output of metals-intensive white goods running at red-hot levels. . The country’s imports of refined copper are booming.

The dollar is down, the yuan is up and the copper-gold ratio is back on the collective investment radar.

Not to mention the demand boost from green recovery plans being rolled out around the world.

Such a run-away rally always has hidden market drivers, as well as more obvious ones.

The LME options market is one and it has acted as an accelerant to an already blazing market as the price surges through layers of short exposure.

THE ACCELERANT EFFECT

London copper has in the last two weeks leapt from less than $7,000 to Monday’s 7-year highs.

In the process, it has broken through multiple layers of December call option strikes with cumulative market open interest of more than 240,000 tonnes.

Another 2,620 lots, or 65,500 tonnes, sit just above the current price action at the $8,000 strike. <0#MCUZ20+>

Back in July, there was a flurry of buying of these options, which confer the right to buy at a pre-determined strike price. Copper was then edging up through the $6,000-per tonne level and the options would have represented a cheap upside punt for early believers in the bull story.

Sellers, on the other hand, probably did not expect the price would be anywhere near $8,000 per tonne by December.

Granting them could have looked low risk, particularly if they were the offset for buying downside put options, a perennial copper producer hedge.

But what are sometimes referred to as “zero-cost” hedging strategies can be anything but if the price rallies through the call option component.

As this copper rally has penetrated ever more layers of options exposure, options shorts will have had to purchase futures to offset their price risk, or delta-hedge as it is known in options market jargon.

The faster the rally, the faster and heavier the collective delta-buying in the underlying market, which is the options accelerant effect.

OUT OF TIME

Time is everything in the options game and with the LME’s December options expiring on Wednesday, time is running out for anyone with exposure to these call options.

A further price surge over the next 24 hours through $8,000 would trigger more buying.

Alternatively, a sharp correction would bring waves of selling from no-longer-needed hedge cover.

LME broker Marex Spectron said in its report to clients on Tuesday that they should expect prices “to chop, especially with Dec options expiry tomorrow”.

“Chop” could yet turn out to be an understatement.

LOOKING UPWARDS

December can often be perilous for options sellers because the month is always relatively liquid with correspondingly large open interest.

What is playing out in copper is mirrored in aluminium and zinc markets, where the strength of recent rallies has also hit critical upside call option levels.

But for the copper market, the potential for options to carry on causing turmoil in the months ahead should not be underestimated.

The LME’s January call options landscape <0#MCUF21+> already shows significant market open interest on the $8,000 strike (750 lots), the $8,200 strike (500) and the $9,000 strike (900).

There are 1,900 lots of market open interest on the $9,000 strike in March and in December 2021 there are already 50 lots open at the $10,000 strike.

Bullish exuberance?

There were plenty who would have thought the same when the December $8,000s were bought back in July.

Options cannot tell you where the market is going to be in December next year. What they can tell you is that if copper is anywhere near the $10,000 level, there will be some very unhappy option shorts.

Credit: Nasdaq

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