Buying Aluminum Call Options to Profit from a Rise in Aluminum Prices

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Contents

Buying Aluminum Call Options to Profit from a Rise in Aluminum Prices

If you are bullish on aluminum, you can profit from a rise in aluminum price by buying (going long) aluminum call options.

Example: Long Aluminum Call Option

You observed that the near-month LME Aluminum futures contract is trading at the price of USD 1,470 per tonne. A LME Aluminum call option with the same expiration month and a nearby strike price of USD 1,500 is being priced at USD 98.00/ton. Since each underlying LME Aluminum futures contract represents 25 tonnes of aluminum, the premium you need to pay to own the call option is USD 2,450.

Assuming that by option expiration day, the price of the underlying aluminum futures has risen by 15% and is now trading at USD 1,690 per tonne. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying aluminum futures at the strike price of USD 1,500. This means that you get to buy the underlying aluminum at only USD 1,500/ton on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying aluminum futures at the market price of USD 1,691 per tonne, resulting in a gain of USD 190.00/ton. Since each LME Aluminum call option covers 25 tonnes of aluminum, gain from the long call position is USD 4,750. Deducting the initial premium of USD 2,450 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,300.

Long Aluminum Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 1,690/ton – USD 1,500/ton) x 25 ton
= USD 4,750
Investment = Initial Premium Paid
= USD 2,450
Net Profit = Gain from Option Exercise – Investment
= USD 4,750 – USD 2,450
= USD 2,300
Return on Investment = 94%

Sell-to-Close Call Option

In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the aluminum option sale will be equal to it’s intrinsic value.

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If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

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Buying (Going Long) Aluminum Futures to Profit from a Rise in Aluminum Prices

If you are bullish on aluminum, you can profit from a rise in aluminum price by taking up a long position in the aluminum futures market. You can do so by buying (going long) one or more aluminum futures contracts at a futures exchange.

Example: Long Aluminum Futures Trade

You decide to go long one near-month LME Aluminum Futures contract at the price of USD 1,470 per tonne. Since each LME Aluminum Futures contract represents 25 tonnes of aluminum, the value of the futures contract is USD 36,750. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 4,375 to open the long futures position.

Assuming that a week later, the price of aluminum rises and correspondingly, the price of aluminum futures jumps to USD 1,617 per tonne. Each contract is now worth USD 40,425. So by selling your futures contract now, you can exit your long position in aluminum futures with a profit of USD 3,675.

Long Aluminum Futures Strategy: Buy LOW, Sell HIGH
BUY 25 tonnes of aluminum at USD 1,470/ton USD 36,750
SELL 25 tonnes of aluminum at USD 1,617/ton USD 40,425
Profit USD 3,675
Investment (Initial Margin) USD 4,375
Return on Investment 84%

Margin Requirements & Leverage

In the examples shown above, although aluminum prices have moved by only 10%, the ROI generated is 84%. This leverage is made possible by the relatively low margin (approximately 12%) required to control a large amount of aluminum represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Aluminum Outlook 2020: Experts Call for Surplus in Years to Come

What’s the aluminum outlook for 2020? Read on to find out experts’ thoughts about the market next year in this overview.

The US-China trade war continued to be a key catalyst for the aluminum market in 2020.

As political tensions escalated during the year, aluminum demand was hurt more than expected, with demand slowing down in China, the largest producer and consumer of the metal.

Read on for a more detailed overview of the main factors that impacted the market in 2020, plus analysts’ aluminum outlook for 2020.

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Looking back at the main trends in the aluminum space in 2020, Wood Mackenzie Senior Analyst Ami Shivkar pointed to global primary aluminum demand, which was at its lowest level in a decade.

“Demand was impacted by the weakness in the automotive and construction sectors in key markets,” she said. “Higher scrap availability also constrained primary aluminum demand.”

With the continued uncertainty surrounding the US-China trade war, demand took a much bigger hit than Wood Mackenzie had expected at the end of last year.

“We still forecast a global metal deficit for 2020 to the tune of 900,000 tonnes, but China and ex-China market trends have now reversed,” Shivkar added.

For the expert, one of the biggest news items in the space this past year was the unanticipated smelter disruptions in China, as participants speculated on how much capacity was affected.

“For the first time since 2009, we estimate that the Chinese primary aluminum market will register a deficit of 600,000 tonnes — despite a sharp slowdown in demand growth,” Shikvar said.

Looking over to prices, the end of September and start of October saw aluminum touch a two year low on the back of escalating US-China trade tensions and a slowdown in global growth.

“Intensifying concerns about demand in China, coupled with slowing factory production in other major industrial nations and a downturn in the global automotive sector, put firm downward pressure on global aluminum prices,” FocusEconomics analysts said in their October report. “Weaker supply and falling inventories — aluminum stocks in LME warehouses dived to over-one-decade low in September — cushioned the downturn in prices.”

Aluminum outlook 2020: Global growth a key risk

As 2020 comes to a close, investors might be wondering what’s next for the aluminum outlook.

“We forecast the world ex-China market to move into surplus over the next few years. In the absence of a supply response, we project an uninspiring price outlook,” Shikvar said.

Wood Mackenzie forecasts an average annual London Metal Exchange (LME) aluminum price of US$1,752 per tonne next year.

Restarts in Canada and Brazil, expansion in Bahrain and the commissioning of SALCO’S 300,000 tonne greenfield project will move the market — excluding China — to a surplus of 700,000 tonnes.

“One could argue that it’s not that the ex-China producers are adding too much capacity, but simply that the demand outlook has deteriorated too much, too quickly to give producers a chance to assess their expansion plans,” Shikvar said.

According to Wood Mackenzie, the global demand picture continues to dampen.

“We estimate global demand to be flat this year followed by a tepid recovery at 2 percent in 2020,” Shikvar said.

Meanwhile, FocusEconomics analysts expect aluminum prices to rise slightly from current levels, largely thanks to healthy global demand.

“That said, an upturn in global supply — including the removal of an operational embargo on Alunorte in Brazil, the planned construction of a ‘green aluminum’ industrial park in Yunnan and the restart of Xinfa capacity in China — will restrain price increases,” states the firm in its report.

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