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Aluminium Options Explained

Aluminium options are a commodity based options contract wherein the underlying financial asset is an aluminium futures contract. These futures contracts are agreements between buyers and sellers to take delivery of an agreed quantity of aluminium on a predetermined delivery date.

The value of the options contracts are based on, among other things, price movements in the futures contract, which in turn, are affected by the current market price of aluminium.

If you own a call option on aluminium, you will profit if the price of aluminium futures rises. This is because a call option gives you the right but not the obligation, to take a long position in the underlying futures.

If you have purchased put options on aluminium, you're anticipating a fall in aluminium futures prices because put options give you the right but not the obligation to take a short position in the futures. Once the options expiration date has passed, your rights to profit from either of these price movements will cease.

Where Aluminium Options are Traded

The place to go for these options prices is either the London Metal Exchange (LME) or the New York Mercantile Exchange (NYMEX). The underlying LME futures contracts each cover 25 tonnes (55,116 pounds) of aluminium and prices are quoted in dollars and cents per metric tonne. Options prices will reflect these underlying values.

The NYMEX Aluminium Options quoted in US dollars and traded in connection with an underlying futures contract covering 44,000 pounds (19.96 metric tons) of aluminium.

If you're bullish on the price of aluminium, you could either buy call options, a bull call debit spread, or sell a bear call credit spread. If you're bearish on aluminium prices, you could buy put options, or a bear put debit spread, or sell bull call credit spreads.

If you don't know which way the price of aluminium will go but believe that its price action will soon become volatile, you could use straddle or strangle option strategies.

Why Aluminium Options and Not Aluminium Futures?

The advantage of trading options instead of their underlying futures, is that you have more opportunities for a variety of trade setups using any number of option trading strategies, some of which are mentioned above. Futures contracts don't provide this flexibility.

Not only that, but with options, your potential losses are always limited to either the amount invested, or the margin used, depending on the type of strategy you're employing. Losses on adverse movements in futures contracts are potentially unlimited.

Moreover, since your options positions are based on the underlying futures contract, you gain additional leverage on price movements. Options on futures are much cheaper than the futures contracts themselves. However, you could also combine aluminium options with their associated futures contracts.

For example, you could hedge long futures positions with put options, or short futures positions with call options. Because the pricing models of these derivatives work differently, you can often use this to realize and overall profit. You could also construct a covered call type setup using both long futures and call options.

There are many interesting alternatives.

With options you should always be aware of option time decay (sometimes called theta decay). If you're an option seller, this works to your advantage, but if a buyer, your out of the money positions will erode rapidly as expiration date approaches.

To start trading aluminium options, simply open an account with any reputable broker such as ThinkorSwim by TD Ameritrade and you'll have the choice of trading futures, options, or both.