Although the futures and options contracts traded at the Comex division of the New York Mercantile Exchange (Nymex) both of which are part of CME Group and overseas at the London Metal Exchange (LME) share approximately the same price movements, they are separated by the time difference between New York City and London.
“Copper futures: Comex and LME” (right) illustrates the close connection between the two prices, charting the daily LME official settlement price and Comex opening price over five months, May 1 through Sept. 30, 2009.
The LME provides for trading in liquid, standardized futures and options contracts in non-ferrous metals, steel and plastics. LME pricing continues 24 hours each day through three methods: a trading ring, an inter-office telephone market and the LME Select electronic trading platform. Official settlement prices result from open-outcry trading between ring dealing members.
LME is a principal-to-principal market in which buyers and sellers wishing to hedge price risk access futures through trading members. The exchange also functions as a market of “last resort,” providing physical delivery as a source of material or as a means to sell excess stock in times of over-supply. In the chart, LME copper is represented by three-month grade-A copper futures.
The trading unit for copper on the Comex exchange is 25,000 lbs of high-grade copper with the symbol HG. Tick size is 0.0005¢ per lb. or $12.50 per contract, and the value of one trading unit is $25,000. In the chart, New York copper is represented by the December 2009 contract.
The LME trading unit for Grade A copper is one tonne (one metric ton, 1,000 kilograms or 2,204.623 pounds of metal). LME prices per tonne are listed in U.S. dollars, and for the purposes of our charts the LME prices are converted to price per pound to approximate the price scale of Comex futures. For example, the LME price for copper grade-A three-month average buy and sell was $6,153 on Sept. 30, 2009. Converted to price per pound, the LME futures produce $2.7910. The opening price per pound on Comex on the same day was $2.7175, for a difference of 7.35¢.
The five-hour time difference between London and New York means that the official settlement prices are announced at the LME at 8:15 a.m. in New York, at the beginning of trading at Comex. This is at 1:15 p.m. in Great Britain, the end of the ring trading session.
IS TIME ON YOUR SIDE?
Given the time differential between London and New York City, is it possible for traders on the Comex exchange to use LME settlement prices to assist in pricing copper futures and options? From May 1 through Sept. 30, the average difference between the opening Comex price for December 2009 copper futures and the three-month copper settlement price on LME was plus 1.51¢. The greatest differences were plus 9.42¢ on Aug. 17 and minus 7.46¢ on Sept. 30.
If the difference between the Comex opening price and LME settlement price is helpful in trading copper futures and options, the effect should be seen in the movement in Comex futures during the day. For each of the 105 days in the four-month sample, the differences between the opening Comex price and London settlement price were ranked in ascending order along with the gains or losses in the Comex price on the same day.
“Negative relationship” (above) includes a scatter chart that demonstrates the correlation between the Comex open and the LME official settlement price. The following change in the Comex price during the day is negative. In general, the larger the opening spread over LME, the more negative the daily price change in the Comex December 2009 futures price, all else being equal. Of interest is the upper left quadrant on the chart, which shows that most price changes during the day were positive when the opening difference was negative. Also noted is that when the opening Comex-LME difference is greater than 0.500, most of the futures price changes on Comex are negative for the day.
The Comex price changes related to the difference between the Comex December 2009 futures price and the LME three-month copper futures settlement price on the same day are shown on “Comex daily price change” (above). The single upward-sloping line represents the opening Comex price each day less the LME price, ranked from the most negative to the greatest positive difference. As indicated above, the differences range from minus 7.46¢ to positive 9.42¢. Below zero, most resulting Comex copper futures price changes are positive, with the trend gradually descending as the opening price difference approaches zero.
When the upward-sloping line on “Comex daily price change” reaches plus 0.500, most changes in the Comex futures price for the day are negative. In terms of overall results, when the opening Comex-LME difference is negative, there are 32 gains and only five losses for Comex December 2009 copper futures for the day, with a cumulative net price gain on long futures of 189.50¢ or $4,737.50. For 20 opening differences above 0.500¢, there are 18 negative changes in the Comex futures price and two positive changes, for a cumulative net gain on short sales of 82.9¢ or $2,072.50.
Although these results look appealing, the time differences between London and New York are not clear-cut. Electronic trading goes on 24 hours, together with telephone trades. Thus, the price differences shown here are approximations of the variations seen by traders on each exchange.
The sample time period for this analysis may be unusual in the number of large positive and negative Comex-LME differences. As shown above, 55% of the opening price differences were either negative or greater than 0.500.
An advantage that LME traders may gain from Comex is price discovery on option trades. LME members quote options over-the-counter and hedge on the exchange through futures. LME members and their clients who wish to hedge copper prices using options may consult lists of strike prices and corresponding put and call options available through Comex and other sources of market data.
An example set of option prices is shown on “Copper option pricing model” (right) with calls on December 2009 copper futures on Oct. 2, 2009. At that time the underlying futures price was 26815, or $2.6815 per pound. Fifteen strike prices are used in the pricing model, ranging from 2.60 to 3.30. Market prices for the call options extend from $0.036 to $0.2385 (for premiums of $90 to $596.25).
On the option price chart “Copper call options”, prices predicted by the regression equation cover the actual market prices, showing their close correlation.
Hedgers on Comex and the London Metal Exchange may benefit from knowledge of the upper and lower breakeven prices at expiration of the December options computed on “Copper option pricing model.” These are prices for copper at the December expiration that the market consensus places at a range from approximately $3.115 to $2.230, distances of plus 16.2% and minus 13.5% from the current futures price. Based on expected volatility in the price of copper, the upper and lower breakeven prices of a current delta hedge correspond to market opinion of the possible high and low prices at the December delivery date.
As we can see from this analysis, the New York-London connections offer advantages both ways — from London to New York City in terms of additional knowledge of copper futures trades early in the day, and from New York to London for transparent and detailed option pricing. It is logical that information flowing between two markets is superior to trading decisions based on a single market.
Paul Cretien is an investment analyst and financial case writer. His e-mail is