Introduction

When navigating the aluminium market, hedging strategies play a crucial role in risk management. Two common methods used by traders and speculators are selling futures and buying put options. While both techniques are employed to benefit from a declining market, they function differently and carry distinct risk profiles. Let’s break it down.

Selling futures – A direct commitment

When you sell futures, you enter a contract that obligates you to sell aluminium at a predetermined price on a future date. If the market price drops, you profit by buying back at a lower price. However, if the market rises, losses can be substantial.

For example, let’s assume you sell aluminium futures at $2,600 per tonne. If prices drop to $2,500, you can buy back at the lower price and pocket a $100 profit per tonne. But if prices surge to $2,700 or higher, your losses grow accordingly, with no fixed limit.

Buying a put option – Limited risk, flexible execution

A put option grants the right, but not the obligation, to sell aluminium at a specific price (the strike price) before the contract expires. You pay a premium for this right, which limits your risk while giving you the potential to profit from price declines.

For instance, if you buy a put option at $2,600 per tonne and prices fall to $2,500, you can exercise the option and sell at the higher strike price. However, if prices rise to $2,700, you are not forced to sell at $2,600; you simply let the option expire, with your only loss being the premium paid.

Comparing the two strategies

Risk exposure: Selling futures carries unlimited loss potential if prices rise, while buying a put caps losses at the premium paid.

Flexibility: A put option gives you the choice to sell, whereas futures require you to fulfill the contract.

Cost consideration: Buying a put requires an upfront premium, whereas futures trading does not.

Conclusion

Choosing between selling futures and buying a put depends on your risk tolerance and market outlook. While futures provide a direct approach, they come with higher exposure. Put options, on the other hand, offer flexibility and limited downside. Understanding these differences is key to effective risk management in aluminium trading.