When it comes to aluminium hedging, the “zero-cost collar” remains one of the most effective tools to balance risk and cost. In this episode of Hedging with Jorge, we dive into the mechanics of how consumers not producers can apply this strategy to secure aluminium prices in uncertain markets.
Recap: Calls and puts in aluminium hedging
In earlier sessions, we explored two key concepts:
- Buying a Call: This provides the right, but not the obligation, to buy aluminium at a fixed strike price.
- Selling a Put: This obligates us to buy aluminium if the counterparty exercises their right to sell.
Individually, both tools serve specific risk management purposes. But when combined cleverly, they can finance one another and create a balanced, cost-efficient hedge.
The zero-cost collar explained
A zero-cost collar is achieved by simultaneously:
- Buying an out-of-the-money call, for example, with a strike price at $2,725 when the market is $2,625. This costs about $52.
- Selling an out-of-the-money put, say, at $2,525, for which you collect about $48.
The premium collected from selling the put almost fully offsets the premium paid for the call. As a result, the overall hedging cost is close to zero hence the name “zero-cost collar.”
How It works for aluminium consumers
- When prices stay within the collar ($2,525–$2,725): Neither option is exercised. The consumer pays the market value as if no hedge existed.
- When prices rise above $2,725: The call is exercised, and the consumer secures protection at the higher strike price.
- When prices fall below $2,525: The put is exercised, obligating the consumer to buy at $2,525, even if the market is lower.
This strategy provides a clear risk boundary: a maximum purchase cost on the upside and a defined obligation on the downside.
Customising the collar to industrial needs
The width of the collar (e.g., $50, $100, $150 difference between strikes) can be adjusted depending on a company’s industrial cost structure and risk appetite. A consumer may decide they are comfortable paying up to $2,725 as a maximum cost, while anything below $2,525 is already favorable.
By tailoring the strike levels, aluminium buyers can lock in predictable costs that align with their budgets and procurement strategies.
Why it matters
In volatile aluminium markets where trade policies, tariffs and shifting demand constantly move prices zero-cost collars offer a disciplined way to hedge without additional financial outlay. They help aluminium consumers secure predictability while leaving room for favorable price movements.
This concludes our deep dive into the zero-cost collar from the consumer’s perspective. Stay tuned for the next episode of Hedging with Jorge where we continue to simplify advanced hedging strategies for the aluminium industry.