Selling (Going Short) Coffee Futures to Profit from a Fall in Coffee Prices

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Selling (Going Short) Coffee Futures to Profit from a Fall in Coffee Prices

If you are bearish on coffee, you can profit from a fall in coffee price by taking up a short position in the coffee futures market. You can do so by selling (shorting) one or more coffee futures contracts at a futures exchange.

Example: Short Coffee Futures Trade

You decide to go short one near-month Euronext Robusta Coffee (No. 409) Futures contract at the price of USD 1,648/ton. Since each Robusta Coffee (No. 409) futures contract represents 10 tonnes of coffee, the value of the contract is USD 16,480. To enter the short futures position, you have to put up an initial margin of USD 1,600.

A week later, the price of coffee falls and correspondingly, the price of Euronext Robusta Coffee (No. 409) futures drops to USD 1,483 per tonne. Each contract is now worth only USD 14,832. So by closing out your futures position now, you can exit your short position in Robusta Coffee (No. 409) Futures with a profit of USD 1,648.

Short Coffee Futures Strategy: Sell HIGH, Buy LOW
SELL 10 tonnes of coffee at USD 1,648/ton USD 16,480
BUY 10 tonnes of coffee at USD 1,483/ton USD 14,832
Profit USD 1,648
Investment (Initial Margin) USD 1,600
Return on Investment 103%

Margin Requirements & Leverage

In the examples shown above, although coffee prices have moved by only 10%, the ROI generated is 0%. This leverage is made possible by the relatively low margin (approximately 10%) required to control a large amount of coffee represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Buying Straddles into Earnings

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

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Investing in Growth Stocks using LEAPS® options

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Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Buying (Going Long) Coffee Futures to Profit from a Rise in Coffee Prices

If you are bullish on coffee, you can profit from a rise in coffee price by taking up a long position in the coffee futures market. You can do so by buying (going long) one or more coffee futures contracts at a futures exchange.

Example: Long Coffee Futures Trade

You decide to go long one near-month Euronext Robusta Coffee (No. 409) Futures contract at the price of USD 1,648 per tonne. Since each Euronext Robusta Coffee (No. 409) Futures contract represents 10 tonnes of coffee, the value of the futures contract is USD 16,480. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 1,600 to open the long futures position.

Assuming that a week later, the price of coffee rises and correspondingly, the price of coffee futures jumps to USD 1,813 per tonne. Each contract is now worth USD 18,128. So by selling your futures contract now, you can exit your long position in coffee futures with a profit of USD 1,648.

Long Coffee Futures Strategy: Buy LOW, Sell HIGH
BUY 10 tonnes of coffee at USD 1,648/ton USD 16,480
SELL 10 tonnes of coffee at USD 1,813/ton USD 18,128
Profit USD 1,648
Investment (Initial Margin) USD 1,600
Return on Investment 103%

Margin Requirements & Leverage

In the examples shown above, although coffee prices have moved by only 10%, the ROI generated is 103%. This leverage is made possible by the relatively low margin (approximately 10%) required to control a large amount of coffee represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

Learn More About Coffee Futures & Options Trading

You May Also Like

Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

How to Trade Coffee Futures

Holly Wilmeth/Getty Images

In terms of sheer monetary volume, coffee ranks at number two on the most commonly-traded commodities list. Coffee is perhaps one of the most interesting, yet volatile commodities to trade.

Coffee is a member of the soft commodities group along with other items grown by farmers, including sugar, orange juice, cocoa, and fruit. Most of these commodities, including coffee, are prone to wild swings in price, and traders must consider a variety of factors about coffee production and demand when making decisions regarding coffee futures.

Coffee Bean Types

There are two main types of coffee: Robusta and Arabica. The coffee traded on the Intercontinental Exchange (ICE) Futures contract in the U.S. is Arabica. The Robusta coffee beans trade at higher prices, in large part due to the demand from large, global customers including Sara Lee, Kraft, Proctor & Gamble, and Nestlé.

These companies together purchase almost 50 percent of all coffee produced worldwide, and they’re known as the “Big 4” coffee roasters. These companies own many coffee-related brands and produce coffee products under various names. Because of the volume of coffee these enterprises purchase, any changes in their demand can affect the prices of coffee futures.

The Arabica bean may be considered higher quality by some in the coffee industry, and you’re likely drinking Arabica bean coffee when you buy Starbucks or other premium coffees.

Regarding trading coffee futures, for simplicity, this article will focus on Arabica beans. The fundamentals of Robusta can affect Arabica prices because Robusta is a very close substitute.

Arabica beans are predominately grown in Brazil, while Columbia is the second largest producer. They are also grown in Central America, but most coffee traders focus on Brazil when they are trading coffee.

Weather Effects

Coffee grows on small trees, so the crops stay in the ground all year. This makes them susceptible to the elements of weather. The trees must flower each spring to produce a good crop, and it’s important to have weather that’s conducive to the trees blooming successfully during this period.

Weather plays a big role in coffee production. Prolonged periods of excessive moisture or dry weather can affect the yield numbers. However, frost or a freeze poses the biggest threat to coffee production. The coffee growing seasons are the opposite of the U.S. since the main crop-growing countries exist in the southern hemisphere.

Most of the biggest moves in coffee prices happen because the trees get damaged by cold weather. Tread carefully when trading coffee futures if the weather forecasts call for extreme cold weather. Coffee can move very quickly and prices will jump higher than many expect if a freeze hits the growing region of Brazil, for example.

Political Stability

Over 65 percent of the world’s coffee beans come from five countries, and if any of those countries experience political instability, this could affect coffee production, scarcity and consequently, prices. Brazil continues to produce over 30 percent of the world’s coffee, followed by Vietnam, then Columbia, Indonesia, and Ethiopia. The market responds very quickly to any events in these countries that could cause a drop in the coffee supply.

Increased Consumer Demand

The demand side also plays a large role in the price of coffee. Europe is the largest consumer of coffee, drinking more per capita in Europe than the rest of the world. The U.S. is also a significant consumer. Developing countries like China and South American countries continue to become more accustomed to coffee and may account for a substantial increase in demand in the coming decades.

Demand typically increases at a fairly reliable level, and people drink coffee in good times and bad. However, if an economy falls into a deep recession, demand for coffee, and likely all commodities, will decline.

Coffee Trading Tips

Coffee futures can make wide swings within each trading day. The extreme price variance makes coffee dangerous to trade on a short-term basis unless you can devote the time to monitoring the markets throughout the day. Successful trading also requires you to be disciplined, control your risk and get out of the market quickly if the trade doesn’t work. Taking profits at your objectives is critical, as the market price can turn very quickly.

Some traders prefer trading coffee over a longer-term horizon. This means looking for bigger moves in coffee over a matter of weeks, as opposed to trying to day-trade the coffee futures market. Sometimes, you may choose to take quick profits if the market makes a windfall move. However, it makes sense to look for larger moves that have a profit ratio of three to one or risking one dollar to make three.

You can also consider trading coffee by selling options instead of using futures contracts. Coffee options typically have a large amount of premium in them because of the market’s penchant for wide price swings. Options can work well in this market because they give you some cushion to withstand the price volatility.

For example, you can sell a put option on coffee, instead of purchasing a futures contract. Selling options carry a good deal of risk, similar to a futures contract. For those that do not trade in the futures market, a product such as the JO ETN has a high degree of correlation with price moves in the coffee futures market.

Many opportunities exist to trade coffee, especially if you can be careful and disciplined. Do your research and construct a trading plan. Get comfortable with cutting your losses quickly, and follow the market for a period, instead of jumping in on day one. The ETN product could be ideal for longer term trading positions as it carries less risk than futures or options. While the ETN can be volatile, it does not have the same degree of leverage as futures and futures options contracts.

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