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

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Buying a Call Option

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Traders buy a call option in the commodities or futures markets if they expect the underlying futures price to move higher.

Buying a call option entitles the buyer of the option the right to purchase the underlying futures contract at the strike price any time before the contract expires. This rarely happens, and there is not much benefit to doing this, so don’t get caught up in the formal definition of buying a call option.

Most traders buy call options because they believe a commodity market is going to move higher and they want to profit from that move. You can also exit the option before it expires—during market hours, of course.

All options have a limited life. They are defined by a specific expiration date by the futures exchange where it trades. You can visit each futures exchange’s website for specific expiration dates of each commodities market.

Finding the Proper Call Options to Buy

You must first decide on your objectives and then find the best option to buy. Things to consider when buying call options include:

  • Duration of time you plan on being in the trade
  • The amount you can allocate to buying a call option
  • The length of a move you expect from the market

Most commodities and futures have a wide range of options in different expiration months and different strike prices that allow you to pick an option that meets your objectives.

Duration of Time You Plan on Being in the Call Option Trade

This will help you determine how much time you need for a call option. If you are expecting a commodity to complete its move higher within two weeks, you will want to buy a commodity with at least two weeks of time remaining on it. Typically, you don’t want to buy an option with six to nine months remaining if you only plan on being in the trade for a couple of weeks, since the options will be more expensive and you will lose some leverage.

One thing to be aware of is that the time premium of options decays more rapidly in the last 30 days.   Therefore, you could be correct in your assumptions about a trade, but the option loses too much time value and you end up with a loss. We suggest that you always buy an option with 30 more days than you expect to be in the trade.

Amount You Can Allocate to Buying a Call Option

Depending on your account size and risk tolerances, some options may be too expensive for you to buy, or they might not be the right options altogether. In the money call, options will be more expensive than out of the money options. Also, the more time remaining on the call options there is, the more they will cost.

Unlike futures contracts, there is a margin when you buy most options. You have to pay the whole option premium up front. Therefore, options in volatile markets like crude oil can cost several thousand dollars. That may not be suitable for all options traders, and you don’t want to make the mistake of buying deep out of the money options just because they are in your price range. Most deep out of the money options will expire worthlessly, and they are considered long shots.

Length of a Move You Expect From the Market

To maximize your leverage and control your risk, you should have an idea of what type of move you expect from the commodity or futures market. The more conservative approach is usually to buy in the money options.

A more aggressive approach is to buy multiple contracts of out of the money options. Your returns will increase with multiple contracts of out-of-the-money options if the market makes a large move higher. It is also riskier as you have a greater chance of losing the entire option premium if the market doesn’t move.

Call Options vs. a Futures Contract

Your losses on buying a call option are limited to the premium you paid for the option plus commissions and any fees. With a futures contract, you have virtually unlimited loss potential.

Call options also do not move as quickly as futures contracts unless they are deep in the money. This allows a commodity trader to ride out many of the ups and downs in the markets that might force a trader to close a futures contract in order to limit risk.

One of the major drawbacks to buying options is the fact that options lose time value every day. Options are a wasting asset. You not only have to be correct regarding the direction of the market but also on the timing of the move.

Break Even Point on Buying Call Options

Strike Price + Option Premium Paid

This formula is used at option expiration considering there is no time value left on the call options. You can obviously sell the options anytime before expiration and there will be time premium remaining unless the options are deep in the money or far out of the money. 

A Stop-Loss Instrument

A call option can also serve as a limited-risk stop-loss instrument for a short position. In volatile markets, it is advisable for traders and investors to use stops against risk positions. A stop is a function of risk-reward, and as the most successful market participants know, you should never risk more than you are looking to make on any investment.

The problem with stops is that sometimes the market can trade to a level that triggers a stop and then reverse. For those with short positions, a long call option serves as stop-loss protection, but it can give you more time than a stop that closes the position when it trades to the risk level. That is because if the option has time left if the market becomes volatile, the call option serves two purposes.

  1. First, the call option will act as price insurance, protecting the short position from additional losses above the strike price.
  2. Second, and perhaps more importantly, the call option allows the opportunity to stay short even if the price moves above the insured level or the strike price.

Markets often rise only to turn around and fall dramatically after the price triggers stop orders. As long as the option still has time until expiration, the call option will keep a market participant in a short position and allow them to survive a volatile period that eventually returns to a downtrend. A short position together with a long call is essentially the same as a long put position, which has limited risk.

Call options are instruments that can be employed to position directly in a market to bet that the price will appreciate or to protect an existing short position from an adverse price move.

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Rising aluminum costs cut into Ford’s profit

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When Ford reports fourth-quarter results on Wednesday afternoon, it is expected to fret that rising metals costs have cut into profits, even as rivals say they have the problem under control. Aluminum prices have risen 20 percent in the last year and nearly 11 percent since Dec. 11. Steel prices have risen just over 9 percent in the last year. Ford uses more aluminum in its vehicles than its rivals.

Aluminum is lighter but far more expensive than steel, closing at $2,229 per tonne on Tuesday. U.S. steel futures closed at $677 per ton (0.91 metric tonnes). Republican U.S. President Donald Trump’s administration is weighing whether to impose tariffs on imported steel and aluminum, which could push prices even higher.

Ford gave a disappointing earnings estimate for 2020 and 2020 last week, saying the higher costs for steel, aluminum and other metals, as well as currency volatility, could cost the company $1.6 billion in 2020. Ford shares took a dive after the announcement. Ford Chief Financial Officer Bob Shanks told analysts at a conference in Detroit last week that while the company benefited from low commodity prices in 2020, rising steel prices were now the main cause of higher costs, followed by aluminum.

Shanks said the automaker at times relies on foreign currencies as a “natural hedge” for some commodities but those are now going in the opposite direction, so they are not working. A Ford spokesman added that the automaker also uses a mix of contracts, hedges and indexed buying.

Industry analysts point to the spike in aluminum versus steel prices as a plausible reason for Ford’s problems, especially since it uses far more of the expensive metal than other major automakers.

“When you look at Ford in the context of the other automakers, aluminum drives a lot of their volume and I think that is the cause” of their rising costs, said Jeff Schuster, senior vice president of forecasting at auto consultancy LMC Automotive.

Other major automakers say rising commodity costs are not much of a problem. At last week’s Detroit auto show, Fiat Chrysler Automobiles NV’s Chief Executive Officer Sergio Marchionne reiterated its earnings guidance for 2020 and held forth on a number of topics, but did not mention metals prices.

General Motors Co gave a well-received profit outlook last week and did not mention the subject.

“We view changes in raw material costs as something that is manageable,” a GM spokesman said in an email.

A spokesman for Volkswagen said while the German automaker had announced it expected higher raw material prices in 2020, it would cut other costs to more than compensate for the increases.

When asked about rising costs, a Jaguar Land Rover spokeswoman said Britain’s biggest carmaker deals with fluctuations in raw material prices by “working closely with our suppliers . and by being well-hedged where necessary.”

Ford jolted the auto industry in December 2020 when it launched the current-generation F-150 pickup truck with an all-aluminum body, shaving 700 pounds (318 kg) off its weight and boosting fuel economy. Ford’s F-series trucks represented the largest-scale use of aluminum in a high-volume vehicle in the auto industry, and required a level of technological risk-taking that had rarely been seen among the Detroit automakers.

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GM and FCA have both stuck mostly with steel in recently unveiled revamped pickup truck models.

Ford also uses a large amount of aluminum in some lower-volume SUV models. But the F-Series pickup trucks, for decades America’s best-selling vehicle line, alone sold almost 900,000 units in the United States in 2020. That was close to 35 percent of Ford’s total U.S. sales.

“These are very profitable vehicles. But a spike in aluminum prices will eat into those profits,” said Sam Fiorani, vice president of AutoForecast Solutions.

But Michael Robinet, managing director of automotive advisory services at IHS Markit said, “I don’t think Ford is an outlier here.”

“The entire industry is facing rising commodity costs and I think Ford has just chosen to highlight it,” Robinet said. (Reporting by Nick Carey; Editing by Jeffrey Benkoe)

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