LONDON (Reuters) - It’s been a hard time for copper bulls.
A year of expected supply disruption from expiring labour contracts has failed to live up to expectations as strike deadlines have largely passed without incident.
Neither accelerated Chinese imports, up 15 percent through August, nor mass cancellations of London Metal Exchange (LME) stocks, 125,000 tonnes over the second half of August, have made any impression.
The LME three-month copper price is down 20 percent on the start of 2018 at a current $6,020 per tonne.
Copper has become a proxy for geopolitical angst, specifically the trade tensions that are simmering between the United States and China.
Wednesday was an “up” day, thanks to the prospect of another round of peace talks between the two protagonists.
But the broader theme remains one of concern about the impact of any new tariffs on global, specifically Chinese, growth. Funds continue to hold a massive short position on the CME copper contract to the tune of a net 25,392 contracts as of last week.
Bulls have struggled to resist the waves of selling from hedge funds and systematic funds chasing the downwards momentum.
But they are still holding the line in the LME copper options market.
Options positioning across the front three months of the LME copper curve remains skewed towards calls, which confer the right to buy, over puts, which confer the right to sell.
Total exchange open interest for calls across the Oct-Dec 2018 quarter stands at 47,230 lots, compared with 28,380 lots on the puts.
Each lot represents 25 tonnes, meaning there are 1.18 million tonnes of open call options and 709,500 tonnes of open put options.
Much of that liquidity is clustered on the December expiry, which is often the case for options positioning across all the LME base metals contracts.
The upside-downside skew is even more pronounced in December with open interest on call options standing at 29,573 lots (739,325 tonnes) and that on the puts at 16,703 lots (417,575 tonnes).
As of Wednesday’s closing valuation at $5,995 per tonne, most of those calls are above the market, “out-of-the-money” unless the price starts rising.
What is surprising is just how high bulls have set their sights.
There are 2,370 lots of market open interest, equivalent to almost 60,000 tonnes, resting on the $10,000-per tonne strike price. That is the third largest concentration of call open interest after the 2,890 lots on the $6,500 strike and the 2,473 lots on the $7,500 strike.
If that sounds ambitious, consider the 340 lots resting on the $11,000 strike, a price level that LME copper has never achieved. The closest it came was $10,190 per tonne during the super-boom year of 2011.
Those bets on copper making it to $11,000, or even $10,000, by the end of the year are a reminder that options positioning offers no magic insight into where the price will go.
Rather, they speak to bullish exuberance, most probably when the copper price was on a charge above $7,000 in June before Doctor Copper became the whipping boy for funds betting on a full tariff war and the expected hit on economic growth.
The most likely outcome is that they will quietly expire “out of the money” once December comes.
However, options can and often do act as an accelerator to any change in price trend as sellers are forced to “delta-hedge” their exposure by buying or selling futures to ensure they are covered when the option expires.
That’s where the sheer size of the call open interest in December may yet prove significant.
If copper rallies to $7,000 between now and then, not an entirely inconceivable prospect, it would bring 12,190 lots, equivalent to 322,750 tonnes, into the money, triggering delta-equivalent buying of futures into a rising market.
If copper made it as far as $8,000, the option market’s collective exposure would rise to over 500,000 tonnes.
And that’s counting only the market open interest published by the LME.
As is often the case with the London Metal Exchange, what you see may only be the tip of a bigger iceberg in the form of over-the-counter options positioning.
Of course, all those upside December call options may pass away peacefully on expiry if the price continues its downwards trajectory.
But the downside momentum has gone for now as the LME price consolidates around the $6,000 level.
And while copper is not going to escape any time soon its role as trade war proxy, there is little room for bearish surprise in the stand-off between the Trump Administration and Beijing.
President Trump has threatened not just another round of tariffs on $200 billion of Chinese goods but tariffs on all U.S. imports from China. Rhetorically at least, there is nothing more to come.
Copper analysts, meanwhile, are almost unanimous in arguing that the price has already fallen too far relative to copper’s own supply-demand fundamentals.
“We think the copper price is currently too low compared to the macro picture ... we maintain a constructive medium-term copper outlook despite strong macro headwinds near-term,” according to analysts at Goldman Sachs (“Metals Monitor”, Sept. 10, 2018).
Goldman is often an outlier on its metals price forecasts but in this case it is firmly in line with the consensus.
The most recent quarterly Reuters poll of analysts, in July, generated a median forecast that cash copper would average $6,900 over the fourth quarter of this year.
That is the view of those paid to follow copper’s micro workings. Right now, the micro is being eclipsed by the macro as speculators focus almost exclusively on the Trump administration’s bellicose trade policy.
If that disconnect ends, copper has a lot of catching up to do with analysts’ forecasts.
Which is where all that open interest on the December copper options might start to impact the price as the hidden accelerator of delta-hedging kicks in.
That said, the buyer of those $11,000 calls is still in all likelihood going to be disappointed as earlier exuberance literally runs out of time come December.
The opinions expressed here are those of the author, a columnist for Reuters.
Editing by David Evans