This scenario, based on a compelling and previously unpredicted perfect storm of supply-demand fundamentals, global trade tensions and, most recently and critically, the targeted US economic sanctions against Russia is being buttressed by the activity and outlook in the LME options market. There, in just a week, implied volatility has jumped from some 16.5% to near 30%. That is an increase of close to 80%, putting this key option pricing indicator at its highest since early-December 2011.
Fueling all this has been the US Treasury Department’s sanctions – on Friday April 6 – that were slammed on Russian oligarch Oleg Deripaska and aluminium producer UC Rusal, which accounts for 7% of global metal supply.
Unsurprisingly, the outright LME three-month price has climbed over 18% from just under $1,980 per tonne since then. Meanwhile, in the sensitive physical market American Metal Market’s assessment of the US Midwest P1020 premium stands at 22-23 cents per lb as of April 13, up 18.4% from 18.75-19.25 cents per lb on April 6.
Likewise elsewhere, the hunt for non-Rusal material helped push the Metal Bulletin Rotterdam duty-unpaid in-warehouse aluminium premium up 20.5% to $125-140 per tonne on Friday April 13 from $105-115 per tonne on Thursday April 12. Meanwhile, the Rotterdam duty-paid premium rocketed from $164-174 per tonne to $200-220 per tonne – the highest since March 2015.
Those rampant premiums, of course, reflect the “here-and-now” situation on the ground. But what of the future – and can the option market provide a useful pointer?
Turnover In the five days prior to the sanctions announcement, LME traded options turnover was around 31,600 lots, which comprised 14,700 calls and 16,900 puts. The slightly higher, but not significantly, number of puts suggests a near-neutral and balanced perception of the market when the outright price was below $2,000 per tonne.
Compare that to the activity and make-up of the five subsequent sessions after the sanctions were announced. Total turnover reached close to 75,000 lots. Of this, calls were near 42,000 lots, but puts comprised just under 33,000 contracts – that’s a more defining tilt towards the bull side.
Over the last week, the May activity has largely been centered around squaring up ahead of the first Wednesday declarations, which are just over two weeks away.
So, secondly, what has been the tenor of recent business?
More upside call business Further ahead, the June and December months have seen a preponderance toward upside call business – in the latter month there has been some 4,500 lots transacted on the $2,500 strike. In June, meanwhile, call option business has been keen, ranging between the $2,300 and $2,600 strikes. There have been over 3,100 contracts traded at $2,600 per tonne.
June and December are months that, as half-yearly staging posts in particular for the investment community, can often be hot spots, where activity and open interest is concerned. Notably, in both these months, there is no put option open interest at present above the $2,275 strike price, which is now out-of-the-money.
In contrast, in June open interest has mostly climbed recently in upside calls, with over 4,100 lots open at $2,350, 8,400 lots at $2,500 and 5,000 lots at $2,600.
In December, too, call option interest has also generally picked up, with over 2,100 lots at $2,500 and 1,500 at the $3,000 strike, for example. December is some eight months away, and a lot can happen in that time, so those numbers are likely to change somewhat during the rest of 2018.
But June is much nearer, so delta-hedging will be much more evident in the coming days and weeks. With no compensating hedge trading or strike position protective plays from the put side, hedging against calls – buying outright market positions as they move into-the-money – may well exaggerate any extension to advances in the short-to-medium term.
A rejuvenated market Current elevated volatility levels have rejuvenated the aluminium market. For several years, volatility has been low, compared with copper – the LME’s other main metal where options are concerned.
In July 2017, front month at-the-money aluminium volatility was below 12.5%, and up to the start of this month, barring occasional spikes to just above 20%, mostly languished in the 15-18% area. Indeed, for most of the last few years, it has averaged an unexciting 15-16%.
It is worth remembering what option implied volatility represents – it is a well-established calculated pricing measure, which is based, both on past performance, and, importantly, predicted movements in the underlying instrument.
So current volatility levels near 30%, although not necessarily a sea-change in the option marketplace, are worth taking notice of. They may indicate that coming fluctuations in outright prices will be wider and more frequent than in recent years.
Also, it can perhaps be said that volatility begets volatility. So, there could be more to come in options in the next few months.
And if current trends become the norm and are a pointer for the rest of the year, the overall aluminium trend will be more to the upside.
Martin Hayes has more than 40 years of reporting experience in metals at Reuters, FastMarkets and most recently as a senior metals market consultant for Metal Bulletin.