A New York-headquartered hedge fund has opened a position in put options that is structured to pay out handsomely if copper prices trade towards $4,000 per tonne by December, market sources told Hotline.
The fund has sold 5,000 puts with a strike price of $4,000 per tonne against the December third Wednesday contract, and simultaneously bought 2,500 puts at both $3,000 and $5,000 in the same contract, trade sources said.
The long butterfly put, as the trade is known, was initiated on June 4, and roughly doubled the open interest against each of the three relevant strike prices in the December contract, exchange data shows.
Being deeply out of the money, the butterfly put offers cheap exposure to a sharp drop in copper prices over the next six months, sources said.
Hotline’s analysis of London Metal Exchange options trade data from Bloomberg indicates that the trade cost the firm just under $4 million in premiums, and will pay out a maximum profit of about $58.5 million if the $4,000 puts expire at the money, commissions not included.
Taking account of the premium paid, the options would break even if the December contract reaches about $4,800 and will remain profitable until about $3,200, after which the fund will once again lose money, up to the cost of the premiums and commissions.
Profitability would peak at exactly $4,000 per tonne, as the $5,000 put options could be exercised at a $1,000 profit, without the fund paying out against the $4,000 options. The maximum payout ratio on the trade is nearly 15:1.
“It’s not a bad-looking trade, and the volumes are the chunkiest we’ve seen for a while. They can just put it on and forget about it for now, and see how it looks closer to expiry,” a source at a rival hedge fund said.
In the run-up to expiry, the value of the options will increase or decrease in relation to movements in the underlying copper price, and the party on the other side of the trade, rumoured to be a large bank, may well seek to buy the option back if copper prices move closer to the first $5,000 strike price, sources said.
“From a mark-to-market point of view, they’ve probably already made a bit of money on it,” the hedge fund source said.
The December 2015 copper contract settled at $5,885 per tonne in Tuesday’s official session, down from $5,948.75 when the options were written on June 4.
There are now more put and call options outstanding against the December date than in any other LME contract, exchange data shows.
“It depends where the copper price is trading, but it could make for an interesting end to the year,” the hedge fund source said.
Mark Burton
mburton@metalbulletin.com
Twitter: @mburtonmb
