Hot Rolled Options: One Use for Service Centers Quoting End User Business
Apr / 13 / 2012 - Hot Rolled Options: One Use for Service Centers Quoting End User Business
Written by: John Packard, Publisher, SMU
The nice thing about sitting through eight or nine Hedging Price Risk workshops is you tend to learn something new each and every time. With the workshop we conducted in partnership with Andre Marshall of Crunch Risk and the CME Group on Wednesday of this week, the one are which tickled my interest based on my past history as a service center and mill sales person was regarding HRO = Hot Rolled Options.
The purpose of our workshop is to learn to manage price volatility and to smooth out cash flows. In the process many other uses of derivatives pop up. For example: Service centers have a specific interest in learning how to offer long-term pricing to end users. End users are interested in how to obtain long term pricing so they can offer firm deals to their customers. The problem is over the past 8 years the extreme price volatility in the flat rolled steel markets plays havoc with those who are financially unable (or unwilling) to handle the gyrations in cash flows and profitability. The use of HR Futures either through the Exchange or OTC (over the counter) markets is a way of smoothing out cash flows if used properly.
So, when and how do HRO – Hot Rolled Options come into play? There are many answers to that question but I will start with a relatively easy one based on my past history working within the service center segment of the market and being responsible for OEM (end user) accounts.
Service centers constantly struggle with the quoting process to their end user customers. In particular how long can you hold an offer as “valid” in a volatile market? In the past (pre-2004) it was not unreasonable to expect the domestic mills to hold a price offer open for a couple of weeks. After 2004 it became common practice for domestic mills to put language in their offers which specified pricing as subject to “final mill confirmation” which basically was their way of saying let the buyer beware – if circumstances change we have the right to re-quote any offer without a purchase order and acknowledgement. This put many deals “at risk” of not being able to be consummated in a volatile markets. This was frustrating for both the service centers and the end users. By the time the end user had done their analysis of the various price offers – the pricing was no longer available.
By using Options a service center can quote firm prices based on existing circumstances with an insurance policy (for which you pay a price) should steel prices change between the time of the initial quote and the expiration date of the offer to their customer. The insurance policy is the Option were you have the ability to exercise the Option and buy steel at “X” price which expires at a point in time negotiated (2 weeks, one month…). The price you pay for the Option is determined by the strike point and the amount of time before the option expires.
Something you may want to consider the next time you have a large quote and prices may be poised to move against you.
Hot Rolled Options (HRO) is new to the products being offered by the CME Group through their Exchange. SMU is aware of only one Option trade being made which was actually done OTC (over the counter) through Andre Marshall of Crunch Risk (our Hedging Price Risk instructor). If you would like to learn more about how to potentially use Options as a tool within your business you would be well served by attending one of our Hedging (Managing) Price Risk workshops the next one being held at the Chicago Board of Trade on July 25th. You are also welcome to contact Andre Marshall which you can do by email at: Andre@CrunchRisk.com.
