Copper from the London Metal Exchange (LME) reached a year-to-date peak on Monday of $7,708.50 per tonne, a volume not traded since March 2013. At the present $7,670, the three-month benchmark contract for the exchange is up by 24 percent at the beginning of the year and by an incredible 75 percent from the March low of $4,371 per tonne.
To explain the rally, copper bulls can choose from a wealth of optimistic drivers.
With the production of metal-intensive white goods operating at red-hot speeds, China’s manufacturing recovery from COVID-19 surpassed all expectations. Imports of processed copper from the world are booming.
On the collective investment radar, the dollar is down; the yuan is up and the copper-gold ratio is back.
Not to mention the surge in demand from the rollout of green recovery plans around the world.
Hidden market drivers, and more visible ones, still have such a run-away rally.
The demand for LME options is one, and it has served as an accelerant to an already blazing market as the price rises across short-exposure layers.
THE ACCELERANT Reality
London copper has soared from less than $7,000 to Monday’s 7-year highs in the last two weeks.
It has broken through several layers of December call option strikes in the process, with more than 240,000 tonnes of combined market open interest.
At the $8,000 hit, another 2,620 lots, or 65,500 tonnes, sit just above the current price action.
There was a flurry of purchases of these options back in July that conferred the right to purchase at a pre-determined strike price. Copper then rose through the $6,000-per tonne mark and the options in the bull story would have represented a cheap upside punt for early believers.
Sellers possibly did not believe that by December the price would be anywhere near $8,000 per tonne.
Granting them may have seemed low risk, particularly if they were the offset, a perennial copper producer hedge, for buying downside put options.
But what is often called “zero-cost” hedging strategies may be anything but if the price rallies through the component of the call option.
As this copper rally has reached ever more layers of exposure to options, short options will have to buy futures to offset their price risk, or delta-hedge, as is known in the jargon of the options market.
In the underlying market, the faster the rally, the faster and heavier the collective delta-buying, which is the options accelerant effect.
OUT FROM TIME
Time is all in the options game and time is running out for those with exposure to these call options with the LME’s December options expiring on Wednesday.
A further price increase to $8,000 over the next 24 hours will prompt further purchases.
Alternatively, waves of selling from no-longer-needed hedge cover will carry a sharp correction.
LME broker Marex Spectron said in a report to clients that they expert prices “to chop”.
“Chop” may also prove to be an understatement.
December can also be risky for sellers of options because, with correspondingly high open interest, the month is often relatively liquid.
In the aluminum and zinc sectors, what is playing out in copper is mirrored, where the speed of recent rallies has also reached crucial upside call options amounts.
But the ability for options to continue causing uncertainty in the months ahead should not be overlooked in the case of the copper market.
The January call options landscape of the LME already shows strong open market interest in the $8,000 strike (750 lots), the $8,200 strike (500) and the $9,000 strike (900).
There are 1,900 lots of open market demand for the $9,000 strike in March, and there are already 50 lots open for the $10,000 strike in December 2021.
Bullish exuberance here?
When the December $8,000s were purchased back in July, there were many who would have felt the same.
Options will not tell you in December next year where the demand is going to be. What they can tell you is that there’ll be some really unhappy option shorts if copper is anywhere near the $10,000 mark.