Executive summary

With global economic indicators potentially giving conflicting signals depending on the country, the most economically sensitive commodity – copper – is faced with crosswinds on the path forward. As a result, Copper options volume and open interest has been rising steadily and is at record highs.  In this week’s report, Rich examines a ratio call calendar spread for exposure and leverage for a possible move higher in copper.

By most accounts, 2022 has been a very macro year. With so much focus on global growth, supply chains, inflation, politics, and geopolitics, it is difficult to avoid the macro discussion. One can’t have this type of discussion without speaking about copper, often referred to as Dr. Copper because it has a PhD in economics.

If you look at where copper is most used globally, this makes sense. The Copper Development Association (CDA) estimates the amount of copper used in each sector to be around 46% building construction, 21% electrical, and about 16% for transportation with the last 17% used in consumer products and industrial machinery/equipment. Essentially, copper use boils down to housing and the electrification of the global economy.

Source: Copper Development Association. "Annual Data 2021: Copper Supply & Consumption 2000–2020," Page 18.

As a result, copper is one of the leading indicators of the global economy. Copper (Figure 1, in blue) has had a good linkage with the global PMI, leading into the 2020 downturn.  While perhaps leading now, it lagged the upturn in 2020 and did not anticipate the V-shaped recovery that came about. 

Figure 1: Copper versus Global Copper Users Purchasing Managers Index (PMI)

Copper may do a better job in some countries than others because those countries are much bigger users of copper. For example, looking at the latest data from Statista, China imports about half of all copper imports globally, so as a result copper may be more sensitive to the Chinese economy.

Figure 2: 2020 leading importers of copper

The latest data on the Chinese economy may give some cause for concern for those tracking the Copper market. Looking at the Chinese housing data that came out this week (Figure 3, in purple) we see the weakest numbers this century. In China, the housing market is also a vehicle through which families save for retirement or try to earn extra income to care for family members. With this meaningful slowdown in housing, it is not surprising to see consumer confidence (in orange) also slowing meaningfully. As a result, many are expecting the Chinese leading indicators and Chinese PMI to follow suit. What will this mean for copper demand in the largest importer of copper in the world?

Figure 3: China Leading Indicators

If we add into this mix the slowdown expected in U.S. housing (Figure 4, in blue), we can start to get a sense why Dr. Copper has had a large pullback and many expect this to continue.

Figure 4: China and U.S. housing versus Copper

Additionally, we don’t want to forget about one of the other large, growing uses of copper – the electrification of the economy. The move toward electrification of the economy is thought to be a multi-year global trend that will unfold, even if there have been some unexpected setbacks this year.  However, the recent Inflation Reduction Act discussions in the U.S., with up to $370 billion in spending on clean energy according to PBS and NPR, has shares in alternative energy companies globally coming off their recent lows and heading higher. We can see over the last five years that copper has had a good correlation to alternative energy shares.

Figure 5: Copper/Alternative energy correlation

Despite or perhaps due to these potential crosswinds, copper is lagging the two major commodity indices. Then it may not be a stretch to think that trend following CTAs are choosing to not hold copper and instead focusing longs on other parts of the market.

Figure 6: Copper/Commodity Index correlation

However, global macro investors keep a close eye on copper, in particular the copper to gold ratio. The copper to gold ratio has always done a good job of keeping a tight coincident relationship with the benchmark U.S. 10-year Treasury yield. That is until very recently.  Does copper see more of a global slowdown while the bond market sees more inflation? Which market is right?

Figure 7: Copper/UST correlation

Perhaps because of these various drivers and the potential dislocation in the price of copper relative to some other benchmarks, such as the broader commodity indices or the 10-year yield, traders and investors have been flocking to the Copper options market. Volume and open interest in copper has been steadily rising all year long and is at record highs.

Figure 8: 2022 Copper options volume and open interest

Looking at the futures market, there is another trend worth observing. According to the Commitment of Traders report over the last six months, as the futures price has gone lower, we have seen producers reduce the size of their short futures positions. We have also seen managed futures reducing longs and adding to shorts.

Figure 9: Copper futures Commitment of Traders (COT)

I have spent a lot of time focusing on the demand side of the equation and less time on the supply side. Looking at the copper inventories at COMEX, we can see inventories are at a five year low, potentially a catalyst for a move higher in the futures with stockpiles at such lean levels.

Figure 10: COMEX Copper Inventories

Turning to the charts, we can see how price and the intersection of the supply and demand dynamic is responding. Like other growth-focused assets (e.g., cyclical stocks or cryptocurrencies), copper has seen a bounce from the lows in the last month. The moving averages have turned up and the situation is not yet overbought. Yet we are about to head into an area of potential churn in the near term. 

Figure 11: Daily Ichimoku cloud chart of Copper

However, the picture looks more positive on a weekly basis. We can see that the generic copper price held the 61.8% retracement of the move from the 2020 lows to the 2021 highs. In addition, we are set up for a MACD crossover and we are coming off a period of where the RSI was more oversold than it was in 2020.

Figure 12: Weekly Ichimoku cloud chart with Fibonacci levels for copper

What is one way to position this in the options market? First looking at the CME Group Volatility Index (CVOL) to get a sense if implied volatilities are relatively high or low versus their own history and relative to other products. We can see that across all metals, implied volatilities are near the lows for the past one year.

Figure 13: One year - CME Group Volatility Index (CVOL) - Metals

Considering the term structure now, we can see the steep contango in the implied volatility term structure.  September and October are deeply discounted relative to the end of the year and 2023 options.

Figure 14: Copper ATM Vol Term Structure

Looking at risk reversal prices, we can see if traders have any preference for upside or downside. While there was a growing preference for downside options in the May through July time frame, their relative pricing is currently very flat .

Figure 15: Copper options risk reversal

Lastly, I want to look at kurtosis (the relative pricing of OTM options vs. ATM options). I can do this on both the call side and the put side. Again, it is all pretty flat suggesting traders are not demanding a premium for OTM options in either direction.

Figure 16: Copper options kurtosis


While pulling this together, I start to see a picture. The global economy is thought to be slowing. As a result, copper has been under pressure and lagging the broader commodity benchmarks.  Managed accounts have reduced longs and added to shorts. Options volume and open interest is growing, yet the level of implied volatility is quite low and there is little incremental demand seen in skew or kurtosis. We do see a steep contango in the implied volatility term structure possibly suggesting calendar spreads could be worth considering. Finally, there are some potentially bullish catalysts. The inventories across the major exchanges are at multi-year lows, producers have reduced their short positions, there is a clean energy bill in the U.S., and the charts are looking more bullish, particularly on a weekly basis.

One possible example is to be net long options, with a bullish lean, but also take advantage of the steep term structure. Believing the bullish catalysts are relatively near term, I want to own shorter dated options but protect myself in case there is a churn as the market tries to digest these moving parts. The example is to buy an October 3.75 call two times and fund this by selling a December 3.75 call. I am buying a 28 vol and selling almost a 30 vol. In spite of the ratio and given the calendar aspect, I am able to do this with no initial cash outlay, but also come away long gamma and marginally long vega.

Figure 17: Ratio call calendar spread

From the catalysts described, the position would benefit in the event of a move higher in the near-term before the October calls expire. The risk to the position is that the front-date calls expire worthless and I am still short the longer dated December calls.

This could happen by moving higher, but not through strike, or by a move lower. If there is a move lower, perhaps as housing and economic data globally deteriorates, since I did this trade zero cost, I would not lose any money. Though the mark-to-market can be difficult. The bigger concern is a very slow move higher, but that will be insulated somewhat because it could well be met with a decline in implied volatility. At least moving down the curve from the 30 vol I sold to the current 28 vol or even lower.

Figure 18: Expected return

The example is not without risks but given the many crosswinds in the Copper market combined with some potential catalysts unfolding in the coming weeks, this idea gives me levered exposure to a move higher in copper as it tries to catch up with the rest of the commodity complex and even the U.S. Treasury yields. If we do get a move higher in the short-term, a structure such as this can add considerable exposure and leverage to the move in copper.

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