In today’s blog of Hedging with Jorge, we continue our journey into the world of aluminium market risk management by exploring a key financial instrument used by hedgers: the call option. While often associated with speculative trading, the use of call options for hedging follows a completely different logic, one that’s more aligned with buying insurance than seeking profit.

Why hedgers think differently from speculators

It’s essential to first distinguish the mindset of a speculator from that of a hedger. A speculator who buys a call option pays a premium and hopes the market price rises above the strike price plus the premium. Their profit lies in exercising the option if the market moves in their favour.

A hedger, however, plays a very different game. When a hedger buys a call, it’s not with the intention to exercise it, it’s for protection. Think of it like car insurance. You don’t buy insurance hoping to crash your car. You buy it in case something goes wrong.

Call options as price insurance

Imagine you are an aluminium trader who has sold primary aluminium at a fixed price, say, $2,650 per metric tonne, plus a premium. However, the metal you’re about to receive has an open QP (quotational period), meaning its price hasn’t been fixed yet and will be set in the future.

This leaves you exposed. If the market price rises, you’re locked into your selling price but have to buy aluminium at a higher cost, cutting into or completely erasing your margins. To hedge this risk, you consider two options:

• Buy futures contracts (cost-free but requires margin and locks you in).
• Buy a call option, a more flexible form of protection.

Hedging strategy in action

Let’s break it down with an example. You believe the aluminium market will go down by $200. However, to protect yourself, you request a quote from your broker and find that a $2,650 call option costs $120 per tonne.

You decide to buy the call. If the market indeed falls to $2,400, the call becomes worthless and you don’t exercise it. Instead, you simply establish a future at the new, lower price. Meanwhile, the premium you paid is a small sacrifice in exchange for protection, just like paying your car insurance premium without making a claim.

But if the market had moved up instead, you would exercise the call and protect yourself from losses. In this way, you’ve limited your risk exposure while preserving upside benefits.

Remember: Hedging with call options isn’t about making a profit, it’s about managing risk and maintaining price certainty in a volatile aluminium market. This analogy with car insurance offers a relatable way to understand why paying a premium upfront can ultimately save you from larger financial setbacks down the line.

If any part of this needs further clarity, feel free to rewatch or reach out via AL Circle. Until next time!