Latest / The Buyer's Side with Fexingo: Procurement, Sourcing, and B2B Purchasing Decisions / How a Buyer Used Option Contracts to Lock in Steel Prices
Transcript
- Lucas: So we talk a lot on this show about negotiation tactics, supplier scorecards, should-cost models — the kind of tools a buyer can use to squeeze cost out of a relationship. Luna: Right, the relational stuff. The art of the deal. Lucas: Exactly. But there is a whole other category of procurement leverage that has almost nothing to do with the supplier relationship and everything to do with financial markets. I'm talking about commodity hedging — specifically, using option contracts to lock in a ceiling price for a raw material. Luna: I feel like hedging is one of those things procurement people talk about in theory but rarely execute. It feels… Wall Street. Lucas: It does. And honestly, most mid-market manufacturers don't do it because it requires a different skill set. But I found a case from a Midwest industrial supplier — let's call them Midwest Metalworks — that did it really well starting in early 2025. Luna: Okay, I'm listening. What was the commodity? Lucas: Hot-rolled coil steel. HRC. It's the benchmark grade for a lot of automotive and construction components. Midwest Metalworks buys about 50,000 tons a year. Their procurement lead — I'll call her Sarah — noticed that HRC futures were trading at around $850 per ton in January 2025, but the forward curve was backwardated — near-term contracts cheaper than longer-dated ones. She thought prices were more likely to rise than fall. Luna: So she wanted insurance. She didn't want to fix the price with a fixed-price contract because that would lock her in if prices dropped. She wanted a ceiling. Lucas: Bingo. She bought call options on CME hot-rolled coil futures. Specifically, she bought 5,000 tons' worth of out-of-the-money call options with a strike price of $900 per ton, expiring in December 2025. The premium was about $25 per ton, so $125,000 total. Luna: And the premium is the cost of the insurance. Non-refundable. If prices stay below $900, she loses the $125K and buys at spot. Lucas: Right. But if prices spike above $900, the option pays out the difference. And here's where it gets interesting — in late March 2025, a major blast furnace at a large domestic steel mill went down for unplanned maintenance. Suddenly, domestic HRC supply tightened. Luna: I remember that. Spot prices jumped to over $1,100 by mid-2025. Lucas: Yeah. By July, HRC was trading at $1,085 per ton. Sarah's options were now deeply in the money. She exercised them, effectively buying at $900 — or rather, she collected the cash settlement of $185 per ton difference, minus the premium, netting $160 per ton. On 5,000 tons, that's $800,000 saved — just on that first tranche. Luna: And she only hedged 10 percent of her annual volume. So there was more room. Lucas: Exactly. She had layered hedges — she bought additional options in March and April as the curve shifted. By the end of the year, she'd hedged about 20,000 tons total. The average strike was around $920, and the average premium was about $30. When prices peaked at $1,150 in September, the payout was huge. Luna: What was the total saving? Lucas: Sarah calculated that versus buying at the average spot price for the year — about $1,040 — her option program saved the company $4.7 million. Against a total premium cost of about $600,000, that's a nearly 8-to-1 return. Luna: That's a home run. But I want to push on the flip side — what if prices had dropped? Say HRC fell to $700. She would have lost the entire premium. How did she justify that to the CFO? Lucas: Good question. She framed it exactly as insurance. You don't buy fire insurance expecting your factory to burn down. You buy it so that if it does, you're covered. The CFO signed off because Sarah showed that a $600K premium was less than 1 percent of total steel spend. And she also structured the options to have a 'floor' — she sold out-of-the-money put options to partially offset the premium. Luna: Okay, that's a collar strategy. Selling puts caps your downside if prices crash, but it also limits upside if they fall below the put strike. Did she do that? Lucas: She did. She sold put options at $750. That meant if HRC fell below $750, she'd have to buy at that price — but since she was buying physical anyway, it actually locked in a good price. The premium from the puts covered about 40 percent of the call premium. So her net premium was about $18 per ton. Luna: Smart. So she wasn't just gambling. She was structuring a risk management program. Lucas: Exactly. And here is the key lesson: she matched the tenor of the options to her physical procurement cycle. Most companies hedge for 12 months out, but Sarah's company had firm orders only 6 months out. So she used options with 6-month expiries and rolled them. That way, she wasn't speculating on prices beyond her visibility. Luna: That's the mistake a lot of procurement teams make — they hedge too far out, and then if demand drops, they're stuck with a hedge that doesn't match their physical exposure. Lucas: Right. Sarah also only hedged 40 percent of her volume. She left 60 percent unhedged to capture any downside. That was a conscious decision — she said, 'I'm not trying to predict prices. I'm trying to survive a spike.' Luna: I love that. So humility about forecasting. Hedging as survival, not speculation. Lucas: And she was transparent with the finance team. She gave them a monthly mark to market report showing the option values. That built trust. By the end of the year, the CFO was asking her to hedge more. Luna: Okay, so practical question for listeners: how does a mid-market buyer even start? You need a brokerage account, a credit line for margin — it's not trivial. Lucas: It's not. But most regional banks have commodity hedging desks. Or you can go to a specialist like FCStone or ADM Investor Services. The key is to start small — maybe 5 percent of volume — and use simple calls, not exotic structures. And get the finance team on board early. Luna: I've also seen procurement teams partner with their suppliers to do hedge-sharing. Like, the buyer and supplier jointly hedge, and if the hedge pays off, they split the savings. Lucas: That's a great model. It aligns incentives. Actually, Sarah's company did something similar with one large supplier — they shared the premium cost, and the supplier gave them a discount on the physical steel. It deepened the relationship. Luna: So this isn't about replacing supplier negotiation. It's about adding a financial layer. Lucas: Exactly. And it's a skill that's increasingly valued. If you're a procurement professional who understands options, you bring something to the table that most buyers don't. Luna: You know, speaking of bringing something to the table — if this conversation has moved your thinking forward in some small way, there's a simple way to support the show. It's buy me a coffee dot com slash fexingo. Lucas: Yeah, that link goes to a page where you can toss a few dollars toward keeping this podcast ad-free. We don't run sponsors, we don't do host-read ads. It's just listener-supported. Luna: And honestly, if today was worth a coffee to you, that's the ask. No pressure. It's buy me a coffee dot com slash fexingo. Lucas: So back to Sarah's story — one more detail I think is instructive. She didn't just buy options and forget them. She actively managed the positions. When the blast furnace outage hit, volatility spiked, and the options became more valuable. She actually sold some of them early, taking profit before expiration. Luna: That's interesting because most people think of options as buy and hold. But you can close them out for cash. Lucas: Right. In June, when the options were already up 300 percent on the premium paid, she sold half the position. That locked in a gain of about $1.2 million. Then when prices kept rising, she bought new calls at a higher strike. It was dynamic. Luna: So she treated it like a portfolio. Not just a single insurance policy. Lucas: Exactly. And that required weekly check-ins with the broker. But the payoff — both in dollars and in credibility — was huge. The company's board now asks for a hedging update at every quarterly meeting. Luna: That's the kind of procurement that gets a seat at the strategy table. Lucas: Yeah. And it didn't require a PhD in finance. It required curiosity, a willingness to learn, and a CFO who trusted the buyer enough to say yes to a pilot. Luna: Alright, I'm going to look into this for my own company. Options on copper might make sense for us. Lucas: Do it. Start small, match the tenor, and report transparently. That's the formula. Luna: Thanks, Lucas. That was a really concrete episode. Lucas: Thanks, Luna. See you next time.