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Building Block Approach: By combining delta, it’s possible to create various strategies by combining calls, puts and futures. Strategies built out of call options can be replicated with put options.


For example, a 3month “Condor” basis market at $5700 and 16% Vol pays a premium of $77/Mt =


- Call 5600 + Call 5800 + Call 6200 – Call 6400 = - Put 5600 + Put 5800 + Put 6200 – Put 6400


In physical contracts, smelters buying concentrates may have “escalator” pricing clauses, where the smelter’s profit increase with market price. These clauses can be replicated and valued using combinations of options to model the implied delta of the contract’s clauses, e.g.


All the derivatives discussed in this article can be described as “analogue” (or “vanilla”), because the value is a linear function of the difference between the Fixed / Strike price and the market price.


“Over-hedging” is a technique applied in structured products and exotic options, where leveraged quantities of analogue derivatives are used to price and create non-analogue derivative outcomes, e.g. perhaps incorporating “knock-out” and “additional tonnage” clauses. Once quite popular in commodity hedging, their use declined sharply after the 2008 financial crash.


In summary, an understanding of delta and the building block approach to derivatives allows various hedge strategies to be designed and priced. It’s a useful skill for strategic hedgers, allowing complex customer hedge books to be analysed, priced, and modified in an efficient manner.


Rohan Ziegelaar E: metals.desk@admisi.com T: +44(0) 20 7716 8081


19 | ADMISI - The Ghost In The Machine | Q1 Edition Source: LME / Reuters / ADMISI


IN PHYSICAL CONTRACTS, SMELTERS BUYING CONCENTRATES MAY HAVE “ESCALATOR” PRICING CLAUSES, WHERE THE SMELTER’S PROFIT INCREASE WITH MARKET PRICE.


Chart 8


Chart 9


Source: LME / Reuters / ADMISI


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