Introduction

When analysing the world of options trading, it’s crucial to approach it from a speculator’s mindset. Unlike hedging, which focuses on risk management, speculation is taking positions based on market expectations.

To put it simply:

• If you believe the market will increase, you buy in the futures market.
• If you expect the market to decline, you sell in the futures market.

This approach is fundamental to trading futures and options on the London Metal Exchange (LME), particularly in aluminium markets.

Trading in the Futures Market

A future contract is a legally binding agreement where the buyer agrees to purchase (or the seller agrees to deliver) a specified quantity of aluminium at a predetermined price on a future date.

In an LME aluminium futures contract:

• Buying a futures contract means you have the right to take delivery of the metal and the obligation to pay for it.
• Selling a futures contract means you are obligated to deliver the metal and have the right to collect payment.

However, not just any aluminium can be delivered under an LME contract. The exchange requires that the metal be LME-branded and meet the P1020 specification:

• Minimum 99.7% aluminium content
• Maximum 0.20% iron and 0.10% silicon content

Understanding Options in Aluminium Trading

While futures trading involves direct buying or selling, options provide more flexibility. With an option, you are not obligated to buy or sell; instead, you have the right but not the obligation to enter a futures contract.

Here’s the key difference:

• You are locked into the trade when you buy in the futures market.
• When you buy an option, you have the choice to enter the trade or let it expire.

This means that with an option, you can choose to exercise your right to buy or sell at a specific price or abandon the contract if market conditions are unfavourable.

Final Thoughts

Options trading allows for greater flexibility and strategic decision-making in LME aluminium markets. As we continue this journey, we will explore deeper insights into option strategies, pricing mechanisms and risk management techniques.