As Iron Ore Hits A 7 Week High, A Look At Hedging Steel Makers

Rough weather in Australia and Brazil Raise Iron Ore Prices

As the Financial Times reported on Friday, iron ore prices have risen 22.5%, to $143.50 per ton, in the last seven weeks, partly due to severe weather in the two countries responsible for 70% of ore production, Australia and Brazil. In Australia, it's been a cyclone affecting shipping of ore:

Port Hedland in Australia, the world's most important port for iron ore exports, has been closed due to cyclone Heidi.

And in Brazil, it's been torrential rains hampering mining operations:

States such as Minas Gerais, the source of more than half of Vale's iron ore output, have been hit by high rainfall since the middle of December, slowing down operations and increasing the risk of accidents and mudslides at open pit mines.

"Minas Gerais", incidentally, means "general mining" in Portuguese, which gives a sense of the centrality of mining to that Brazilian state.

Hedging a handful of leading Steel Makers

With the rise in iron ore prices, I was curious to see how much it cost to hedge a handful of leading steel makers, as iron is the main ingredient in steel. The steel makers I looked at are a diverse group, but Nucor Corporation (NUE) stands out as being primarily a steel recycler, using scrap steel as an input in manufacturing its steel products. Perhaps that's why it was the least expensive of these stocks to hedge. The table below shows the costs of hedging Nucor and 5 other steel makers against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the cost of hedging the SPDR Dow Jones Industrial Average ETF (DIA) against the same decline, using optimal puts. First, a reminder about what optimal puts are, and a note about the decline threshold we're using here; then, a screen capture showing the optimal puts for the most expensive of these stocks to hedge, AK Steel Holding Corporation (AKS).

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, "threshold" is the maximum decline you are willing to risk. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I've used 20% decline thresholds for all the names below.

The Optimal Puts For AKS

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of AKS against a greater-than-20% drop between now and June 15th. A note about these optimal put options and their cost: To be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true for the other names in the table below).

Hedging Costs As Of Friday's Close

The hedging costs below are as of Friday's close and are presented as percentages of position values.

Symbol	Name	Hedging Cost
X	US Steel Corporation	13.1%**
GGB	Gerdau S.A.	7.68%*
MT	Arcelor Mittal	10.7%*
AKS	AK Steel Holding Corporation	15.2%*
SID	Companhia Siderurgica	14.2%*
NUE	Nucor Corporation	4.54%**
DIA	SPDR DJIA	1.49%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.