Market and product

The recent spike in iron ore prices, which saw 10-day volatility hit 100% in the second week of March, will be repeated throughout the year as short term ‘black swan’ effects drive spot cargo demand and buoy shipping rates, according to FIS.

The increase in March volatility has been attributed to the announcement of an output increase in the Hebei region until the end of April before output restrictions are enforced to reduce pollution during the Agricultural Expo.

Traders should be looking to take advantage of opportunities from future spikes, which might be politically-driven and are unconnected to the broader macro-economic picture, says FIS Strategy Director Michael Gaylard.

“The re-focussing of the Chinese economy means that volatility of this kind will be a feature of the market across the year, with short term clamour for cargo feeding volatility and pushing up spot freight rates. This should not be mistaken for a change in the fundamentals of iron ore or Capesize freight but it is indicative of the kind of short term squeeze traders should expect in 2016.”

Even though it still remains outside of published commodity indices, the strength of iron ore volatility and traded volume set it apart from its peers. The commodity bear market has been most severe in iron ore (The Steel Index decreased 80% between Feb 18 2011 and Dec 11 2015) but has also created countless trading opportunities for those already active in the market.

Iron ore/base metal spreads have become more and more popular with metals traders, as they look to take advantage of the percentage disparity between these related commodities. These spreads often trend between their moving averages and outer percentage bands, creating trading opportunities often in the region of 8% to 15%.

An options trader who had access to the iron ore market would have had plenty of opportunity to buy the implied volatility and position themselves nicely for the recent volatility spike, after seeing historical volatility increasing in the rest of the base metals sector.

Iron ore is not always a lagging indicator and should be in every commodity trader’s book, be it for intra-market spreads, options or to just take advantage of the trading environment, says Gaylard.

“Iron ore has often been regarded as a lesser cousin to the base metal set. Despite its position as a leading indicator of the Chinese economy, many financial trading institutions continue to sit on the sidelines and not include it within their trading baskets. As the second largest commodity traded by volume after oil, iron ore is now at a stage where it has become too big to ignore, and must be accepted as a mainstream commodity.”