Managing price risk is crucial when you are involved in commodities trading, especially in industries like copper mining where prices can fluctuate significantly over time. In this scenario, we will explore the net cash position with and without the use of a put protection strategy for a copper mine planning to sell 800 metric tons of copper three months from today. The put option in question grants the right to sell 1 metric ton of copper for $6.40 per kilogram.

Without Put Protection:

To calculate the net cash position without the use of a put protection strategy, we need to consider two scenarios: one where the spot price of copper is $5.10 per kilogram and another where it is $6.80 per kilogram, both occurring three months from now.

i. Spot Price = $5.10 per kilogram

Without put protection, if the spot price is $5.10 per kilogram in three months, the revenue from selling 800 metric tons of copper can be calculated as follows:

Revenue = 800 metric tons × 1,000 kg/metric ton × $5.10/kg = $4,080,000

Now, let’s calculate the net cash position:

Net Cash Position = Revenue – Cost of production

It’s essential to note that the cost of production may vary, but for simplicity, we are considering only the revenue and ignoring production costs in this example. However, in a real-world scenario, production costs would need to be factored in.

ii. Spot Price = $6.80 per kilogram

Similarly, if the spot price of copper is $6.80 per kilogram in three months without put protection, the revenue would be:

Revenue = 800 metric tons × 1,000 kg/metric ton × $6.80/kg = $5,440,000

And the net cash position would be calculated as:

Net Cash Position = Revenue – Cost of production

Again, the net cash position would depend on the actual production costs, which are not considered in this simplified example.

With Put Protection

Now, let’s consider the scenario with the use of a put protection strategy, which involves the purchase of put options allowing you to sell copper at a predetermined price of $6.40 per kilogram.

Regardless of whether the spot price of copper is $5.10 or $6.80 per kilogram, with the put protection strategy, you have the right to sell your copper at $6.40 per kilogram. Therefore, your revenue remains fixed at:

Revenue = 800 metric tons × 1,000 kg/metric ton × $6.40/kg = $5,120,000

In this case, your net cash position is also determined by subtracting production costs from the fixed revenue of $5,120,000.

Conclusion

In summary, employing a put protection strategy provides price certainty, ensuring that you can sell your copper for a predetermined price of $6.40 per kilogram, regardless of fluctuations in the spot market. This offers a level of price risk mitigation that can help stabilize your revenue.

Without put protection, your net cash position depends on the unpredictable spot price of copper, which can lead to uncertainty and potentially lower revenues. However, it’s crucial to consider the cost of purchasing and maintaining the put options in your overall financial strategy.

Ultimately, the choice between using put protection or not depends on your risk tolerance, cost-benefit analysis, and confidence in predicting future copper prices.