Excell with Options: Examining Opportunities in Aluminum & Copper

I have two charts up on my computer that I routinely go through. I learned early in my career that the best traders, even outside of the commodity complex, like to look at these industrial metals (ALE1 and HG1) priced in terms of gold (GC1) in order to take the FX effects out of the price. Thus, a trader might be able to ascertain a solid view of the commodities market’s sense for supply and demand. Since May, as both of these measures have shown extreme weakness, it has led to a number of commentators wondering if the global economy is entering into a period of meaningful economic slowdown.

Ideally, a trader would like to compare these two futures markets’ measures to a global GDP to see how closely they match the actual economic output. After all, the latest GDP reading in the U.S. was 5.2% in nominal terms, while it was 4.7% in China. That might sound like reasonable economic growth to many. Interestingly, those measures do not correlate well with the futures market. Instead, I have found that the U.S. ISM (orange) and the Chinese Li Keqiang Index (yellow) do a much better job. The ISM is a survey of business conditions in the U.S. and it coincides with asset markets while GDP lags. There have also been criticisms of the Chinese GDP, which is why I use the Li Keqiang Index on Bloomberg. When he was Premier of China from 2013-2023, a reporter asked Li about GDP. Li said he did not like the man-made data but preferred real measures like rail traffic, electricity consumption and bank lending. Bloomberg put that index together. A trader can see that both the ISM and Li Keqiang do a good job of tracking the futures markets, if not leading them. To me, both suggest there could be downside here even though the narrative is about a soft landing and rate cuts now in the U.S.

Now I turn to each of the futures markets individually and look to the futures themselves and not those priced in gold. I can see a similar shape where each has been under tremendous pressure suggesting those earlier moves had little to do with gold and more to do with the supply/demand of the futures themselves. In the top chart of aluminum, we can see a chart that has broken solidly through the Ichimoku cloud, which attempts to find the zone of where buyers and sellers are. In fact, this cloud is starting to turn lower suggesting a trend change may be afoot. On the positive side I see the MACD in the middle panel is starting to turn higher, though it has not crossed yet. Importantly, in the bottom panel, the RSI appears to be solidly oversold and has not been this oversold this year.

The Copper market is very similar to this. Price has moved below the cloud and the cloud is turning lower. The MACD is showing signs of turning higher but may not yet be as far along as aluminum. The same is true for RSI, which is only marginally oversold and has touched this level of oversold in the past year.

While neither chart looks particularly healthy, it may be easier to make a call for a trading bounce in aluminum than in copper. 

Now I want to get a sense for how the volatility markets are reacting to these moves. I move to the CVOL page at CME Group to first get a look at where each product is trading relative to its last year of trading, but then to also compare each to the other Metals products to see if anything stands out. At the top of the page, I see that aluminum CVOL is at 18, on the lower end of its one-year range of 16.25-29.75. Copper, on the other hand, is higher in both absolute terms (27.43), but also relative to its one-year trading range of 14.46-40.70. Traders in copper appear to be expecting a bit more volatility in copper than in aluminum, at least according to CVOL.

Not only do I want to look at the overall CVOL levels, which uses all strikes to calculate the level of volatility, but I want to look at the skew ratios for both. The skew ratios give me a sense if the supply or demand of options in these markets is being driven by upside or downside options. When this ratio is rising, there is more relative demand for upside options. When it is falling, there is more relative demand for downside options. In the top chart, one can see that the trend in Aluminum options has been for the downside until a very recent spike higher. The opposite is true in copper where the trend had been for upside options until a recent spike lower in the last set of data. Do I trust the trend or the spike? I tend to trust the trend and not the spike, but I want to investigate further.