Should you melt down your pennies?

by on April 13, 2006 at 7:27 am in Economics | Permalink

My much-beloved Financial Times gets one wrong:

It could soon be worth Americans melting down their pennies for scrap, if zinc and copper prices continue their current rate of increase.

Copper prices have risen 30 per cent so far this year, and zinc is up 55 per cent – a rise of about $550 a tonne in a little more than three weeks.

A rise by the same magnitude would make the metal content in the US one cent coin worth more than its face value.

The weight of 160 pennies – also known as a one cent coin – comes to a pound, worth a face value of $1.60. But – with each penny made of 97.5 per cent zinc and 2.5 per cent copper – based on current prices, the metal value is worth about $1.36. Therefore another 25 cents-a-pound rise in zinc, or about $551 a tonne, would see the metal value of the US penny worth more than the monetary value.

We all know, of course, that you should not exercise an option before its expiration.  The longer time runs, the greater the chance for price to bounce around.  Once you are "out of the money," further drops in price don’t hurt you any.  But "in the money," you gain from price movements in your favor.  So hold onto those pennies and wait.  Yes there are complications (what is the stochastic process governing these prices?) but most likely the standard result holds up.

nick April 13, 2006 at 7:39 am

That’s because when an option’s value rises, it’s replacement cost rises also. Here the replacement cost (of pennies) is fixed. So if the metal is worth more than the face value, you should sell it as metal – then change the proceeds into pennies and repeat until uneconomical?

sammler April 13, 2006 at 8:14 am

You should not exercise a call on a non-dividend-paying asset before its expiration — this is not true for every option. (Consider the option to refinance your mortgage.)

In this case, by exercising earlier, you can sooner reinvest the proceeds of the sale, so it may truly be optional.

ridiculous April 13, 2006 at 8:27 am

you have a basically unlimited supply of pennies available. if you can easily sell the copper, there is no point in maintaining the optionality of the pennies you have – you can easily use the proceeds to buy MORE of teh options you started out with. this should not be viewed as an option, but simply as a pure arbitrage.

Independent George April 13, 2006 at 9:56 am

Or, you could hoard pennies with the intention of making your own set of copper cooking pans.

Also: the current (mostly zinc) composition of pennies was established in 1983. Pre-1983 pennies were almost entirely made copper.

Bernard Yomtov April 13, 2006 at 11:22 am

When exactly does this particular option expire?

And doesn’t the “don’t exercise before expiration” rule only apply to options that are readily marketable, so that sale of the option is more lucrative than exercise?

nelsonal April 13, 2006 at 12:02 pm

Does collectabilty become the vehicle through which the “time value” of the premium is expressed? If enough people melt their zinc/copper pennies and they become rare, and a floor is established at melt value then does the rarity become the option premium? If not that then I’m in agreement with the others, that the storage costs probably greatly exceed any potential time value in the options.
Is there some way to fix the text box slipping behind the ads as soon as one starts to type?

Anonymous April 13, 2006 at 1:46 pm

Anthony: Probably copper-plated steel, like Canadian pennies since 2001.

(By the way, the Canadian penny was 98% copper until 1997! So don’t be upset if you get one in your change…)

ModalHubby April 13, 2006 at 4:18 pm

I really like Sammler’s idea — but I think the way to do it is to short OPTIONS on zinc & copper, not the futures. This turns the transaction into a “covered call.” If the price ends up above the strike price, melt ‘em and deliver (or suffer a loss on your short call and then a gain on the physical sale, if they’re cash-settled contracts rather than physical-delivery contracts.

The key to the strategy is that, with some probability p, the closing price will not exceed the strike price. It’s silly to sink the cost c of converting pennies to the zinc/copper mixture unless you know you’re forced to do so. By using options rather than futures, you save an expected cost of pc. This probabilistic cost savings would make it attractive to be “bolder”, selling calls with lower strike prices.

So we shouldn’t be melting down the pennies, but we should be planning (and contracting now) now to get paid to exercise our real option to melt down the pennies in the future. This way, we can get paid whether we melt ‘em or not.

An added benefit: the metals market may not yet have factored in the price-dampening effect of extra supply, which will come on the market when melting becomes profitable. Thus, the price should hit a ceiling when melting pennies becomes profitable, but the option prices won’t reflect the fact that a big move ABOVE that level is a long shot.

DK April 13, 2006 at 5:53 pm

Anon: How is a mortgage a put? Taking out a $100K 5% mortgage is equivalent to selling the bank a $100K 5% amortizing bond, but retaining the option to call the bond back in whole or in part.

Sammler and Anon: I agree with you that it is similar to the pennies with storage costs. But he real (highly technical) issue that makes mortgages different is that interest rates tend to revert to the mean over time, while stock and other asset prices tend to go up. You also have reinvestment risk and a lot of other wrinkles that don’t apply to stocks.

lee April 13, 2006 at 6:12 pm

We haven’t heard from a metallugist yet. Don’t count the higher value of the copper until you know how to separate it and the cost of that. But the question for the metallugist is: if you don’t separate it out how will 2.5% copper effect the use of the things zinc is used for?

Tim Worstall April 14, 2006 at 5:58 am

I’m not a metallurgist but I have dealt in scrap metal: including coins. A decade and more ago we bought 36 tonnes (two entire truckloads) of nickel silver (which is actually doesn’t contain silver at all) coins in Russia. The huge inflation of the early 90s (thousands of percent a year) had made the meltable value hugely higher than the face value.
We didn’t make a huge profit, as above, most of that went to the people who did the collecting and sorting but it was worth trucking it all from the Urals into a European refinery.
Not all that important I know, I just like the fact that I did once buy two truckloads of coins.

KipEsquire April 14, 2006 at 9:46 am

And while we’re on the subject, we should also make clear that the phrase “you should never prematurely exercise a call option” is only true as opposed to selling it. Exercising as opposed to selling simply destroys the option’s time value, or “theta,” which can never be rational.

But if there no secondary market in which you could sell the call option (e.g., employee stock options), then it could be perfectly rational to exercise it prematurely.

Demming April 14, 2006 at 11:44 am

Why do U.S. “Pennies” exist at all now ??

Who needs them ?

Today’s ‘penny’ is worth about one-tenth that of a year-1950 penny, in inflation-adjusted purchasing power.

Today’s U.S. ‘dime’ is the equivalent of a 1950 penny.

Americans in 1950 surely did not need or use
‘Tenth-of-a-Penny’ coins. They don’t need them now either.

Abolish both the current U.S. penny & nickel.

And with standard U.S. Government inflation rates, dimes & quarters will also soon be unnecessary to the citizenry.

Probably the only reason our penney & nickel are still official currency … is because the Feds don’t want to highlight their erosion of American fiat currency.

Phoebe April 14, 2006 at 8:12 pm

DK, and how exactly would you replicate the continuous-payoff of pennies in the real world?

I say the FT got it right.

aloke April 16, 2006 at 6:44 pm

KipEsq – “premature” exercise is not restricted to US markets.
American and European are just naming conventions, they can trade
anywhere. Otherwise you’d always have to go to Bermuda to buy
Bermudans…

I know it is a bit far afield, but since employee stock options entered
the discussion above, here is another interesting article -
http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/esops.pdf

A bit more accessible… (no PDEs!)

Cindy July 8, 2006 at 8:43 pm

Where and who do you sell the pennies and nickles that are to be melt down at and to? A scrap dealer or what?

Gordon August 9, 2006 at 5:24 pm

Does anyone know the copper value of 1.00′s worth of pennies….of pre 1981 minting?

Allen September 6, 2006 at 12:51 pm

uh, Carlton, it’s not a crime to melt down coins, just to fraudulently deface coins (trying to turn a quarter into a Susan B. Anthony dollar, or something). People have been melting down old silver coins for decades.

james December 16, 2006 at 3:18 pm

the U.S. Mint said Wednesday they were putting into place rules prohibiting the melting down of 1-cent and 5-cent coins. The rules also limit the number of coins that can be shipped out of the country. The new regulations prohibit the melting of 1-cent and 5-cent coins, with a penalty of up to five years in prison and a fine of up to $10,000 for people convicted of violating the rule.

However…. I didnt know the U.S. Mint has the authority to make law??? The new regulations are being published in the Federal Register and will go into effect as interim rules which will not become final until the government has a chance to consider possible modifications based on public comments.

David J. Heinrich January 30, 2007 at 12:45 pm

Also, in response to the post by Ryedale, advertising the Ryedale coin sorter (which sorts pure pre-’81 copper pennies from more recent pennies, it seems quite pricey for something so simple.

I haven’t done a lot of research, but it seems to me that there must be a weight difference between pure-copper and debased penny coins. So, it seems like all you need to do is modify a standard $20 coin-sorter from Walmart to have some kind of flap, where pennies heavier than a certain weight can fall through it into one bin, and pennies lighter than a certain weight can’t.

Ryedale July 26, 2007 at 12:13 am

I have a new model available for $299. If your interested please drop me an email andy@ryedalecoin.com
Sorts over 300 coins per min.

jeannie March 20, 2008 at 12:53 am

I just read this !!
We don’t want to see our pennies and nickels melted down so a few individuals can take advantage of the American taxpayer. Replacing these coins would be an enormous cost to taxpayers.”

The new regulations authorize a fine of up to $10,000, or imprisonment of up to five years, or both, against violators.

The rule also bans the exportation of the coins, beyond traveling with $5 worth and shipping up to $100 for legitimate purposes.

rambo goldburg May 10, 2008 at 11:12 am

go to the bank and gets all the pennies you can.

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