***SPOTLIGHT: NOS clears first iron ore option

The over-the-counter (OTC) market for ferrous derivatives is growing — both in terms of volume and sophistication

Another option? NOS Clearing could provide fillip to OTC swaps liquidity

The over-the-counter (OTC) market for ferrous derivatives is growing — both in terms of volume and sophistication.

At least one interdealer broker is now regularly quoting a forward curve on flat products. And last week the first OTC iron ore option cleared through NOS Clearing.

The option was brokered through Geneva-based Kyte Broking and was for 180,000 tonnes, according to Norwegian clearing house NOS, which declined to reveal the counterparties involved in the transaction.

But market participants told MB a leading investment bank wrote the option and fingered a large Switzerland-based trading company as the buyers.

The option was a put on a Q1/Q2 2011 spread, they said, although the precise details remained under wraps.

“The buyer of the option doesn’t want it out there — it’s a very good trade for him,” one source said.

“Essentially the buyer of the option has covered themselves for any downward movement in the iron ore market in this period,” he told MB.

NOS launched clearing for monthly cash-settled Asian-style options on November 1. The options are for 62% Fe content iron ore fines cfr China, and first settlement will be determined against the average of the index at the end of the period in question.

“Iron ore options are going to be a very important risk management tool going forwards, and we are in positive discussions with a large number of end users keen to get involved,” said Kyte Broking’s Jos Evans, who joined the company recently from London Commodity Brokers’ Asian office.

“The introduction of cleared cash-settled iron ore options will add value, and will complement and add liquidity to the existing futures market,” said John Wright, head of GFI’s London iron ore desk.

Indeed, news of the option clearing provided a fillip to OTC swaps trading, which made an understated start last week.

Traded volumes initially spiked to more than 100,000 tonnes on Tuesday. On November 17 market players took stock. But a flurry of new business the next day saw traded tonnage rise again to something in the region of 70,000 tonnes.

Swaps tied to deliveries in December changed hands at $158 per tonne cfr Qingdao, also on a 62% Fe basis, with a November/December spread trading in a $0.50 backwardation.

The January 2011 prompt changed hands twice at $157, while a Q1/Q2 spread also traded in a $3.75 backwardation.

Thursday transactions valued second-quarter deliveries at $153 and a February swap was sold at $155.5.

With the Metal Bulletin Iron Ore Index (MBIOI) calculating at $158.29 per tonne cfr Qingdao on a 62% Fe basis, down slightly on November 17 levels, this put the market in a clear backwardation.

The availability of cleared options should encourage more market participants to come to the table and lead to more liquidity in the swaps market, brokers said.

“Liquidity will definitely improve in the OTC market if options writing starts up,” a second broker said. “There are four or five guys very actively looking at the market.”

But, while there is strong interest in further options trades, it could be some time before the market sees another cleared transaction.

“We have lots of people interested as buyers, but not many wanting to write contracts,” another broker said.

Fortunately a number of leading investment banks familiar with market-making in more established environments are gearing themselves up to trade.

“We are working very closely with a number of market participants who will use the options market to hedge their forward risk,” said Macquarie Bank head of freight and iron ore David Abzatz.

“We’re gearing up to trade options,” a source at another investment bank said, telling MB the company was in the process of obtaining the necessary approvals from NOS.