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Nervous copper traders eye $6,000/t puts as prices skid lower

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Copper traders are nervously eyeing two big put option trades at $6,000 and $5,500 per tonne, which they fear could accelerate the market’s longest rout in years as prices sink to their lowest since 2010.

Two of the biggest options positions in the copper market – equivalent to almost 210,000 tonnes of copper – are puts expiring in June that allow the holder to sell at $5,500 and $6,000 per tonne if prices have dropped below those levels, according to data from the London Metal Exchange.

On Friday, three-month prices sank to as low as $6,073 per tonne, their weakest since June 2010.

It isn’t clear who bought the positions, although some traders say it was likely a hedge fund. A big portion of these trades were placed in November and mid-December, data shows, when three-month copper was around $6,500 per tonne, a comfortable distance from the strike prices.

Now though after a month-long steady slow grind lower, prices are within striking distance of the $6,000 mark, amplifying their significance and putting traders on edge about a potentially deeper punishing rout.

The question is whether whomever sold the options – likely a bank or dealer, traders say – have adequately hedged the risks that those options now expire in the money, forcing them to pay out at a price potentially higher than the spot market.

To hedge their exposure, they would need to sell futures, threatening to extend a selloff that has wiped 15 percent off copper prices since July as demand from top consumer China has waned amid concerns over credit and a slowdown in construction.

“Dealers will feel naked. I think that’s a big issue,” said one London-based market source. A U.S. trader said the “orderly” decline in prices so far shows the market’s not panicking yet.

Closest to being in the money are 3,906 lots of puts at $6,000 per tonne, with a larger 4,449 lots at a strike price of $5,500 per tonne. Combined they represent 12 percent of exchange put option liquidity, according to LME data.

Both levels are psychologically important markers for the $66 billion market, with $5,500 close to or below breakeven level for many producers.

Implied volatility has spiked in those options to around 25 this week from an average of 16 last year, suggesting increased activity.

“The market’s nervous as we move down there,” a London-based trader said. “It feels like it’s on the edge.”

Source: Reuters

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Metals · Raw materials

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