Will Steel Industry Benefit From US HRC Options Contracts?

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MetalMiner welcomes guest columnist Brad Clark, a senior derivatives broker who leads the St. Louis office of FIS Ltd., the London-based global commodity interdealer broker. Mr. Clark brokers physical and derivative deals on steel, iron ore, scrap and freight with a focus on the domestic US market.

Over the past six months, the US HRC futures contract has seen extraordinary growth in terms of volume.

It is clearly emerging that the US HRC futures contract is not only becoming the steel contract of choice among participants looking to gain exposure to the US steel market, but also increasingly adopted by the domestic US steel industry as a prudent way to manage risk in volatile markets.

In the first six months of this year, volumes were 152,000 tons (25,000 tons/month). Since July however, volumes came in at 429,000 tons (71,500 tons/month) for a total year-to-date of 580,000, a 35 percent increase from total 2010 volumes.

I am happy to write that the Chicago Mercantile Exchange is launching a new product, an options contract on the US HRC, which will further complement the existing futures contract. This new options contract for the domestic US steel industry and those looking to gain exposure to this dynamic market will provide traders and risk managers another avenue to express their market views in potentially a less risky way.

While both futures and options contracts fall under the umbrella of derivatives, there are significant differences which I will outline below.

Options are derivatives contracts whereby traders either purchase or offer the right to buy or sell an underlying futures contract at a predetermined strike price in return for a set premium. There are two types of options: calls and puts. You can buy calls, which give you the right to purchase the underlying futures at a certain strike price for a certain premium; or you can write calls, which grant someone the right to purchase the underlying futures contract at a determined price for a premium.

Alternatively, you can purchase puts, giving you the right to sell a futures contract at a certain level, while writing puts grants someone the right to sell a futures contract at a given level in return for a premium paid.

Options buyers can significantly limit their risk to the market because purchasing an option gives the buyer a known risk at the outset, as the risk is limited to the total premium paid. For instance, if one were to buy 1,000 tons per month of US HRC Q1 call options with a strike of 720 and a premium of $20, the total risk outlaid for this contract is:

The premium x the quantity; so $20 x 3,000 tons, for a maximum risk of $60,000.

However, the upside is unlimited above a ‘breakeven’ of $720/ton. Conversely, writers of options experience unlimited risk with a known premium, which in the case above would be $60,000.

Options give US steel market participants the ability to hedge their risk with a known risk from the outset. Options in other metals markets play a significant risk management role for companies looking to hedge their production (buying puts), upcoming purchase requirements (buying calls), or looking to profit from a range-bound market (selling strangles, buying collars, etc.).

The launch of this new contract for the US HRC market is yet another reminder of the domestic US steel industry’s growing financial sophistication as companies across the supply chain utilize every available resource to manage risk and maximize profitability.

–Brad Clark

 

*FIS and CME Group will jointly host a webinar on the launch of the US Midwest Domestic Hot Rolled Coil Steel Average Price Options Contract.

WHEN: December 13th at 10:30AM New York (3:30PM London)

WHO: Attendees will hear from Brad Clark of FIS and Patricia Cauley of CME Group on the benefits of the options contract to the steel industry.

HOW: Register at www.fissteelswaps.com/options-registration

Login at this link: https://www1.gotomeeting.com/join/511513544

Audio will available online.

Otherwise call in for audio: United Kingdom: +44 (0) 207 151 1804 United States: +1 (909) 259-0010

WHAT: Topics that will be covered include the specifications of the contract, the mechanisms needed to trade the contract and scenarios to implement a trade into your business.

QUESTIONS: Call FIS at 314-727-7411, Email at info@fissteelswaps.com

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