In previous blogs of Hedging with Jorge, we explored how put options function for investors and speculators. Now, it’s time to look at how these same tools can support hedgers, those who aim to protect value rather than speculate on market movement.

Let’s start with the basics, like why would a hedger buy a put?

Imagine you’ve bought 100 tonnes of aluminium. You’re concerned about the possibility that prices might fall. In this situation, you have two common hedging tools:

• Sell futures
• Buy a put option (which gives you the right to sell at a specified price)

Here’s the key difference, futures cost nothing upfront, while options require a premium. So why would anyone choose to buy a put?

Because puts offers protection without obligation. Much like car insurance, you buy it not because you expect an accident, but just in case one happens. The same applies here. You don’t expect the aluminium price to fall, but you want protection if it does.

Let’s revisit an example used earlier:

Strike Price: $2,400

Premium: $70

Expiry: May

You are not speculating on a drop. You are simply ensuring that, if the market does fall, you are protected. But ideally, you never want to use that put. Why? Because you’d prefer prices to rise, just like you’d prefer never to use your car insurance.

Now, here’s the interesting bit, why choose an option over a futures contract if it comes with a premium?

Suppose the market goes up to $2,600. If you had hedged using futures by selling at $2,400, you’d miss out on the upside. But with the put, you just let it expire and enjoy the $200 gain on your physical commodity. You paid $70 for the option, but your aluminium is now worth much more.

So, a long put becomes your protective shield, allowing you to sleep better at night, knowing your downside is covered. And if the market moves in your favour? You reap the benefits without the limitations of a locked-in futures contract.

This subtle difference is what makes options attractive to hedgers who want protection with flexibility.

Stay tuned for more insights as we continue to simplify the world of aluminium price risk management, one strategy at a time.