In this blog of Hedging with Jorge, we take a fresh look at call options and explore why a hedger might choose to pay a premium on a call instead of using futures, even when the futures curve is flat. To simplify the concept, Jorge draws on an everyday analogy, car insurance and highlights how call options can work as a risk management tool for aluminium transformers and consumers.

Understanding calls: The right to buy and why it matters

A call option gives you the right not the obligation to buy an asset (like aluminium) at a specified strike price before expiry. Think of it as insurance: you pay a premium upfront for the protection, knowing you’re covered if prices spike.

Here’s the scenario: as a transformer or aluminium consumer, you’re selling secondary alloy at a fixed price. However, the primary aluminium you purchase has a floating price. To protect against price increases, you need to hedge.

You have two options:

• Use futures, where there’s no premium.
• Buy a call option, where you pay a premium but retain flexibility.

Currently, for aluminium, a one-month call option premium is around $100 a significant cost for protection against price volatility.

Calls vs Futures: The hedger’s dilemma

At first glance, paying a premium for a call seems unnecessary when futures contracts don’t require it. But Jorge explains the key rationale:

• If you’re confident prices will rise, buying futures locks in your protection with no upfront cost.
• If you believe prices might fall, paying a premium for a call allows you to hedge against upside risk while potentially benefiting from lower market prices.

Here’s the breakeven calculation:

Strike Price: $2,600

Premium: $90

Breakeven: $2,600 – $90 = $2,510

If you expect prices to drop below $2,510, a call option makes sense because it protects you while leaving room for cost savings if the market dips.

Hedging strategy: Full calls or hybrid approach?

You don’t have to hedge entirely with calls. Jorge suggests a hybrid strategy:

• Use 90% futures for cost-effective hedging.
• Add 10% call options to introduce a speculative element and maintain flexibility.

This way, you’re not fully exposed to premium costs but still have some upside protection.

Remember: Any hedger using calls or puts inherently introduces a speculative view into their strategy. That’s not only acceptable it’s often necessary in dynamic markets.

When calls are mandatory

In certain cases, you may have no choice but to use call options. For example:

• You lack the cash for margin requirements on futures.
• Calls offer a more accessible hedge, even if they come at a cost.

As Jorge concludes, the decision between futures and calls comes down to cost tolerance, market view and liquidity considerations.

“We spend our lives speculating, but with calls, you speculate wisely while staying protected.”