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October 27 2010| Filed Under Derivatives, Futures, Options
The soft markets are made up of cocoa, coffee, cotton, orange juice and sugar,
some of the oldest commodities still around today. You can trace their roots in
commerce back over thousands of years. It is important to note that trading in
this market involves substantial risks and is not suitable for everyone, and
only risk capital should be used. In this article, we'll show you how to use
this "sweet" market properly, because any investor could potentially lose more
than originally invested.
What are soft futures contracts?
A soft futures contract is a legally binding agreement for the delivery of
cocoa, coffee, cotton, frozen concentrated orange juice and sugar in the future
at an agreed upon price. The contracts are standardized by the ICE Futures
U.S., previously known as New York Board of Trade (NYBOT), and regulated by the
Commodity Futures Trading Commission, as to quantity, quality, time and place
of delivery. Only the price is variable. (To read more about futures, see
Futures Fundamentals, Interpreting Volume For The Futures Market and Becoming
Fluent In Options On Futures.)
Most futures contracts are offset prior to delivery, meaning that most
contracts are speculators trying to profit off of price movements.
Advantages of Futures Contracts
Unlike equities, futures contracts can be shorted on a downtick, which gives
market participants greater flexibility. This flexibility allows hedgers to
protect their physical position and speculators to take a position based on
market expectations.
Because the soft commodity markets are traded at an exchange, the clearing
services ensure no default risk. This means that the exchange acts as buyer to
every seller should a market participant have to default on its
responsibilities.
Market Personality
With the merger of the NYBOT and Intercontinental Exchange (ICE) in 2007, and
after these markets went electronic, volume increased substantially.
Contract Specifications
Although there are other sugar and coffee contracts that trade around the
world, this piece deals only with those traded at the ICE Futures U.S.
1. Cocoa
Discovered by the natives of Central America more than 3,000 years ago, cocoa
was originally a luxury for the very rich. Today, most of the world's cocoa is
grown in a handful of countries: the Ivory Coast, Ghana, Indonesia, Brazil,
Ecuador and Nigeria.
Cocoa is traded in dollars per metric ton and one contract is for 10 metric
tons. For example, when cocoa is trading at $1,500/M ton, the contract has a
total value of $15,000. If a trader is long at $15,000/M ton, and the markets
move to $1,555/lb, that is a move of $550 ($1,500 - $1,555 = $55, and 55 x 10 M
ton. = $550).
The minimum price movement, or tick size, is a dollar, or $10 per contract.
Although the market frequently will trade in sizes greater than a dollar, one
dollar is the smallest amount it can move.
The contracts month for delivery of sugar are March, May, July, September and
December. Delivery points include licensed warehouses in the Port of New York
District, Delaware River Port District, Port of Hampton Roads, Port of Albany
or Port of Baltimore.
2. Coffee
Coffee was originally discovered in Ethiopia more than 2,000 years ago. From
Africa, coffee found its way to the Middle East and into coffee houses. It was
these coffee houses that gave coffee its exposure to many travelers, which
spread its use outside the Arabian borders.
Coffee is traded in cents per pound. One contract of coffee controls 37,500
pounds of coffee. When the price of coffee is trading at $1/pound, the cash
value of that contract will be $37,500 ($1.00 x 37,500 = $37,500).
The tick size is 5 cents per pound, which equates to $18.75 per tick. For
example, if a trader were to go long at $1.1000 and the markets moved to
$1.1550, he would have a profit of $2062.50 ($1.1550 - $1.1000 = $0.0550, and
$0.0550 x 37,500 = $2,062.50).
Because it one of the larger contracts in dollar terms, little movements have a
big impact on price. Coffee has one of the larger daily ranges of all the
softs, making it a very volatile commodity.
Coffee is deliverable in March, May, July, September and December. Delivery
points are worldwide in ports around the globe like New Orleans, New York,
Houston, Miami, Hamburg, Antwerp and Barcelona.
3. Cotton
Because cotton has universal appeal and can be used in many different products,
it has been one of more influential commodities. Discovered more than 5,000
years ago, cotton has played a vital role in the rise and fall of many
countries. It was one of America's first cash crops.
Cotton is traded in 50,000-pound contracts. It is also traded in cents per
pound, so if the market is trading at 53 cents per pound, the contract will
have a value of $26,500 ($0.53 x 50,000 pounds = $26,500).
The minimum tick size is $0.0001 or $5 per contract. Therefore any 2 cent move
in cotton will equate to either a gain or a loss of $1,000. When the price of
cotton exceeds 95 cents per pound, the minimum tick movement will expand to
$0.0005 to accommodate to the larger daily ranges.
March, May, July, October and December are the contract months for cotton.
Delivery points are in Galveston, Houston, New Orleans, Memphis and Greenville/
Spartanburg, which isn't too surprising considering that is where most of it is
grown.
4. Frozen Concentrated Orange Juice
Orange juice is a relative newcomer to the commodity markets. For centuries, OJ
was consumed as fresh fruit juice because it had a relatively short shelf life
and was susceptible to price shocks due to supply disruptions. Freezing OJ was
invented in the 1940s and quickly became the industry standard.
One contract of FCOJ equals 15,000 pounds. If the current market price is 90
cents per pound, the contract has a value of $13,500 ($0.90 x 15,000 pounds =
$13,500).
The minimum tick is $0.005, or $7.50 per tick per contract. For example, let's
say you buy a contract of FCOJ when the market is at 95 cents, and then sell it
for $1. In this transaction, you would make $750 on the 5 cent move in FCOJ.
Oranges that come from Brazil and Florida are deliverable in exchange-licensed
warehouses in Florida, New Jersey and Delaware only. FCOJ is most actively
traded in January, March, May, July, September and December.
5. Sugar
It is widely believed that humans first used sugar well over 2,000 years ago.
Originally only reserved for the very rich, sugar has become one of the more
common staples on the dinner table. Because of its mass appeal, sugar is
usually one of the most heavily traded commodities in the world in terms of
total volume.
Sugar trades in contracts of 112,000 pounds as well as in cents per pound. If
the futures price is $0.1045, the contract has a value of $11,704 ($0.1045/lb x
112,000 pounds = $11,704). If the market moves from $0.1000 to $0.1240, that is
equivalent to a dollar move of $2,688.
The minimum price movement for sugar is $0.0001 or $11.20 per contract.
Sugar is only deliverable in March, May, July and October. There are delivery
points in each nation where the sugar is produced. These are places like
Argentina, Australia, Barbados, Belize, Brazil, Colombia, Costa Rica, Dominican
Republic, El Salvador, Ecuador, Fiji Islands, French Antilles, Guatemala,
Honduras, India, Jamaica, Malawi, Mauritius, Mexico, Mozambique, Nicaragua,
Peru, Republic of the Philippines, South Africa, Swaziland, Taiwan, Thailand,
Trinidad, United States and Zimbabwe. (To find out more about global trends in
these commodities, see Taking Global Macro Trends To The Bank.)
Conclusion
There are many different opportunities in soft commodities markets. Any person
looking to invest should carefully consider the risk involved and be aware of
the contract specifications before investing.
by Hank King
Hank King currently works at Trendphonics at the Chicago Board of Trade as a
senior broker. He has been in the business since 2000 and has worked as a
Nasdaq trader for Great Point Capital, a clerk on the floor of the CBOT with
Fimat and as an account executive with Morgan Stanley and Lind Waldock. King
has his Series 3 license and graduated from the University of Arizona with a
major in art history.