Upload
ngoni-mukuku
View
226
Download
1
Embed Size (px)
Citation preview
7/27/2019 Commodity Marketing
1/21
Commodity Marketing
Introduction
The term commodity is commonly used in reference to basic agricultural products that areeither in their original form or have undergone only primary processing. Examples include
cereals, coffee beans, sugar, palm oil, eggs, milk, fruits, vegetables, beef, cotton and rubber.
A related characteristic is that the production methods, postharvest treatments and/or primary
processing to which they have been subjected, have not imparted any distinguishing
characteristics or attributes. Thus, within a particular grade, and with respect to a given
variety, commodities coming from different suppliers, and even different countries or
continents, are ready substitutes for one another. For example whilst two varieties of coffee
bean, such as robusta and arabica, do have differing characteristics but two robustas, albeit
from different continents, will, within the same grade band, have identical characteristics in
all important respects. Agricultural commodities are generic, undifferentiated products that,
since they have no other distinguishing and marketable characteristics, compete with one
another on the basis of price. Commodities contrast sharply with those products which have
been given a trademark or branded in order to communicate their marketable differences.
Agricultural commodity marketing system
A commodity marketing system encompasses all the participants in the production,
processing and marketing of an undifferentiated or unbranded farm product (such as cereals),
including farm input suppliers, farmers, storage operators, processors, wholesalers and
retailers involved in the flow of the commodity from initial inputs to the final consumer. The
commodity marketing system also includes all the institutions and arrangements that effect
and coordinate the successive stages of a commodity flow such as the government and its
parastatals, trade associations, cooperatives, financial partners, transport groups and
educational organisations related to the commodity. The commodity system framework
includes the major linkages that hold the system together such as transportation, contractual
coordination, vertical integration, joint ventures, tripartite marketing arrangements, and
financial arrangements. The systems approach emphasises the interdependence and inter
relatedness of all aspects of agribusiness, namely: from farm input supply to the growing,
assembling, storage, processing, distribution and ultimate consumption of the product.
7/27/2019 Commodity Marketing
2/21
Stages in agricultural commodity marketing
The marketing systems differ widely according to the commodity, the systems of production,
the culture and traditions of the producers and the level of development of both the particular
country and the particular sector within that country. This being the case, the overview of the
structure of the selected major commodities marketed, which follows, is both broad and
general. The major commodities whose marketing systems will be discussed in this chapter
are: large grains, livestock and meat, poultry and eggs, cotton, fruit and vegetables and milk.
Table 6.1 identifies the main stages of agricultural marketing and this provides a loose
framework around which to structure the discussion of the marketing of these commodities.
This is a general model and therefore not all of the stages it describes are equally applicable
to the commodities selected for discussion. This being so, certain stages are given more or
less emphasis; and for some commodities specific stages are omitted altogether from the
discussion.
Table 4.1 Stages of agricultural commodity marketing
Stages Activity Example
Stage 1 Assembly Commodity buyers
specialising in specific
agricultural products, such
commodities as grain, cattle,
beef, oil palm, poultry and
eggs, milk.
Stage 2 Transportation Independent truckers,
trucking companies,
railroads, airlines etc.
Stage 3 Storage Grain elevators, public
refrigerated warehouse,
controlled-atmosphere
warehouses, heated
warehouses, freezer
warehouses
Stage 4 Grading and classification Commodity merchants or
7/27/2019 Commodity Marketing
3/21
government grading officials
Stage 5 Processing Food and fibre processing
plants such as flour mills, oil
mills, rice mills, cotton mills,wool mills, and fruit and
vegetable canning or freezing
plants
Stage 6 Packaging Makers of tin cans, cardboard
boxes, film bags, and bottles
for food packaging or fibre
products for
Stage 7 Distribution and retailing Independent wholesalers
marketing products for
various processing plants to
retailers (chain retail stores
sometimes have their own
separate warehouse
distribution centres)
Characteristics of agricultural commodities
Agricultural commodities differ in nature and contents from industrial goods in the following
respects.
Agricultural commodities tend to be bulky and their weight and volume are great fortheir value in comparison with many industrial goods.
The demand on storage and transport facilities is heavier, and more specialized in caseof agricultural commodities than in the case of manufactured commodities.
Agricultural commodities are comparatively more perishable than industrial goods.Although some crops such as rice and paddy retain their quality for long time, most of
the farm products are perishable and cannot remain long on the way to the final
consumer without suffering loss and deterioration in quality.
7/27/2019 Commodity Marketing
4/21
Most agricultural products are produced seasonally; this condition of seasonalproduction and availability is not found in the case of industrial goods.
Finally, both demand and supply of agricultural products are inelastic. A bumpercrop, without any minimum guaranteed support price from the government may spelldisaster for the farmer.
Commodity (futures) exchanges
Since the early development of agricultural markets, producers have attempted to protect
themselves against falling commodity prices at harvest time. Many producers ignored
marketing techniques and sold their commodities at harvest regardless of the price. Today,
producers have realised that a marketing strategy is equal in importance to production,capital, and labour strategies.
Forward contracts
The development of forward contracts was a major step in allowing producers to reduce
marketing risks. Forward contract is a cash market transaction in which a seller agrees to
deliver a specific cash commodity to a buyer at some point in the future. The price is
specified in a cash forward contract for a specific commodity. The forward price makes the
forward contract have no value when the contract is written. However, if the value of the
underlying commodity changes, the value of the forward contract becomes positive or
negative, depending on the position held.
Example
Before a wheat farmer plants his crop, he executes a contract with a cereal company for the
delivery and purchase of 75,000 bushels of wheat at a price of $1 per bushel. The actual
exchange of the wheat for money will, of course, not take place until after the crop is
harvested in the fall. By entering into a forward contract, both the farmer and the cereal
company reduce their respective risks. By pre-selling his crop at $1 per bushel, the farmer has
protected himself against the risk that in the fall the then-current price (orspot price) will be
lower than $1 per bushel. The cereal company, on the other hand, by pre-purchasing has
protected itself against the risk that in the fall the spot price of wheat will be greater than $1
http://www.investorwords.com/775/cash_market.htmlhttp://www.investorwords.com/5046/transaction.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.investorwords.com/756/cash_commodity.htmlhttp://www.businessdictionary.com/definition/buyer.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.investorwords.com/770/cash_forward_contract.htmlhttp://www.investorwords.com/975/commodity.htmlhttp://www.investorwords.com/5579/forward_price.htmlhttp://www.investorwords.com/2057/forward.htmlhttp://www.investorwords.com/1079/contract.htmlhttp://www.investorwords.com/5209/value.htmlhttp://www.investorwords.com/7046/change.htmlhttp://www.investorwords.com/3748/position.htmlhttp://www.investorwords.com/2299/held.htmlhttp://www.investorwords.com/2299/held.htmlhttp://www.investorwords.com/3748/position.htmlhttp://www.investorwords.com/7046/change.htmlhttp://www.investorwords.com/5209/value.htmlhttp://www.investorwords.com/1079/contract.htmlhttp://www.investorwords.com/2057/forward.htmlhttp://www.investorwords.com/5579/forward_price.htmlhttp://www.investorwords.com/975/commodity.htmlhttp://www.investorwords.com/770/cash_forward_contract.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.businessdictionary.com/definition/buyer.htmlhttp://www.investorwords.com/756/cash_commodity.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.investorwords.com/5046/transaction.htmlhttp://www.investorwords.com/775/cash_market.html7/27/2019 Commodity Marketing
5/21
per bushel. Both parties to the transaction sacrifice the possibility of getting a better price for
themselves in exchange for eliminating the risk of getting a worse price.
When harvest time arrives, the spot price will either be higher or lower than $1 per bushel
depending on the normal circumstances that affect supply and demand. If the price at harvest
has risen to, say $1.35 a bushel, the farmer will undoubtedly wish that he had not entered into
the forward contract. The cereal company, however, will be quite pleased to pay a below-
market price of $1 per bushel. On the other hand, if the spot price in the fall drops to $0.75
per bushel, the farmer will be delighted to be getting the above-market price of $1. The cereal
company, of course, will not be so thrilled to have to pay $1 per bushel when the market rate
is $0.75. In this contract, as with all forward contracts, the buyer is pleased if the agreed-upon
contract price is lower than the spot price and the seller is happy if the contract price is higher
than the spot price.
Changes fr om forward contracts to fu tures contracts
Forward contracts had a lot of drawbacks. They were not standardized in terms of quality or
delivery time, and merchants and traders did not always fulfil their forward commitments.
Due to these drawbacks, steps were taken to formalize commodity trading by developing
standardized agreements called futures contracts.
Futures contracts
This is a contractual agreement, generally made on the trading floor of a futures exchange, to
buy or sell a particular commodity at a pre-determined price in the future. Futures contracts in
contrast to forward contracts were standardized as to quality, quantity, and time and location
of delivery of delivery for the commodity being traded. The only variable is price, which is
set through an auctionlike process on the trading floor of an organized exchange.
Example
A producer of wheat may be trying to secure a selling price for next season's crop, while a
bread maker may be trying to secure a buying price to determine how much bread can be
made and at what profit. So the farmer and the bread maker may enter into a futures contract
requiring the delivery of 5,000 bushels of grain to the buyer in June at a price of $4 per
bushel. By entering into this futures contract, the farmer and the bread maker secure a price
7/27/2019 Commodity Marketing
6/21
that both parties believe will be a fair price in June. It is this contract - and not the grain per
se - that can then be bought and sold in the futures market.
So, a futures contract is an agreement between two parties: a short position - the party who
agrees to deliver a commodity - and a long position - the party who agrees to receive a
commodity. In the above scenario, the farmer would be the holder of the short position
(agreeing to sell) while the bread maker would be the holder of the long (agreeing to buy). A
futures contract has the same general features as a forward contract but is transacted through
a futures exchange.
Unlike futures contracts (which occur on a trading floor), forward contracts are privately
negotiated and are not standardized. Further, the two parties must bear each other's credit
risk, which is not the case with a futures contract. Also, since the contracts are not exchange
traded, there is no marking to market requirement, which allows a buyer to avoid almost all
capital outflow initially (though some counterparties might set collateral requirements).
Given the lack ofstandardization in these contracts, there is very little scope for a secondary
market in forwards. Forwards are priced in a manner similar to futures. Like in the case of a
futures contract, the first step in pricing a forward is to add the spot price to the cost of carry
(interest forgone, convenience yield, storage costs and interest/dividend received on the
underlying). Unlike a futures contract though, the price may also include a premium for
counterparty credit risk, and the fact that there is not daily marking to market process to
minimize default risk. If there is no allowance for these credit risks, then the forward price
will equal the futures price.
Purpose of commodity (futures) markets
Futures exchanges, no matter how they are organized and run, exist because they provide two
vital economic functions for the marketplace: risk transfer and price discovery. Futures
markets makes it possible for those who want to manage risks-hedgers- to transfer some or
all of that risk to those who are willing to accept it speculators.
Buying futures contracts
Futures contracts are not formalized contract written by an attorney, they are legally binding
agreements, made on the trading floor of a futures exchange, to buy or sell something in the
future. That something could be corn, soybeans, wheat, tobacco, live beef or some other
http://www.businessdictionary.com/definition/futures-contract.htmlhttp://www.businessdictionary.com/definition/cash-forward-contract.htmlhttp://www.investorwords.com/3610/party.htmlhttp://www.investorwords.com/437/bear.htmlhttp://www.investorwords.com/1210/credit_risk.htmlhttp://www.investorwords.com/1210/credit_risk.htmlhttp://www.investorwords.com/2136/futures_contract.htmlhttp://www.investorwords.com/1797/exchange.htmlhttp://www.businessdictionary.com/definition/marking-to-market.htmlhttp://www.businessdictionary.com/definition/capital-outflow.htmlhttp://www.businessdictionary.com/definition/set.htmlhttp://www.investorwords.com/929/collateral.htmlhttp://www.businessdictionary.com/definition/requirements.htmlhttp://www.businessdictionary.com/definition/standardization.htmlhttp://www.businessdictionary.com/definition/scope.htmlhttp://www.investorwords.com/4422/secondary_market.htmlhttp://www.investorwords.com/4422/secondary_market.htmlhttp://www.investorwords.com/2134/futures.htmlhttp://www.businessdictionary.com/definition/pricing.htmlhttp://www.investorwords.com/4663/spot_price.htmlhttp://www.investorwords.com/1154/cost_of_carry.htmlhttp://www.investorwords.com/2531/interest.htmlhttp://www.investorwords.com/6771/convenience_yield.htmlhttp://www.investorwords.com/4762/storage.htmlhttp://www.investorwords.com/1148/cost.htmlhttp://www.investorwords.com/3785/premium.htmlhttp://www.businessdictionary.com/definition/counterparty.htmlhttp://www.investorwords.com/1193/credit.htmlhttp://www.investorwords.com/4292/risk.htmlhttp://www.businessdictionary.com/definition/fact.htmlhttp://www.businessdictionary.com/definition/daily.htmlhttp://www.investorwords.com/2962/market.htmlhttp://www.businessdictionary.com/definition/process.htmlhttp://www.investorwords.com/1351/default_risk.htmlhttp://www.investorwords.com/5402/allowance.htmlhttp://www.businessdictionary.com/definition/credit-risk.htmlhttp://www.investorwords.com/2138/futures_price.htmlhttp://www.investorwords.com/2138/futures_price.htmlhttp://www.businessdictionary.com/definition/credit-risk.htmlhttp://www.investorwords.com/5402/allowance.htmlhttp://www.investorwords.com/1351/default_risk.htmlhttp://www.businessdictionary.com/definition/process.htmlhttp://www.investorwords.com/2962/market.htmlhttp://www.businessdictionary.com/definition/daily.htmlhttp://www.businessdictionary.com/definition/fact.htmlhttp://www.investorwords.com/4292/risk.htmlhttp://www.investorwords.com/1193/credit.htmlhttp://www.businessdictionary.com/definition/counterparty.htmlhttp://www.investorwords.com/3785/premium.htmlhttp://www.investorwords.com/1148/cost.htmlhttp://www.investorwords.com/4762/storage.htmlhttp://www.investorwords.com/6771/convenience_yield.htmlhttp://www.investorwords.com/2531/interest.htmlhttp://www.investorwords.com/1154/cost_of_carry.htmlhttp://www.investorwords.com/4663/spot_price.htmlhttp://www.businessdictionary.com/definition/pricing.htmlhttp://www.investorwords.com/2134/futures.htmlhttp://www.investorwords.com/4422/secondary_market.htmlhttp://www.investorwords.com/4422/secondary_market.htmlhttp://www.businessdictionary.com/definition/scope.htmlhttp://www.businessdictionary.com/definition/standardization.htmlhttp://www.businessdictionary.com/definition/requirements.htmlhttp://www.investorwords.com/929/collateral.htmlhttp://www.businessdictionary.com/definition/set.htmlhttp://www.businessdictionary.com/definition/capital-outflow.htmlhttp://www.businessdictionary.com/definition/marking-to-market.htmlhttp://www.investorwords.com/1797/exchange.htmlhttp://www.investorwords.com/2136/futures_contract.htmlhttp://www.investorwords.com/1210/credit_risk.htmlhttp://www.investorwords.com/1210/credit_risk.htmlhttp://www.investorwords.com/437/bear.htmlhttp://www.investorwords.com/3610/party.htmlhttp://www.businessdictionary.com/definition/cash-forward-contract.htmlhttp://www.businessdictionary.com/definition/futures-contract.html7/27/2019 Commodity Marketing
7/21
commodities. In other words, a futures contract establishes a price today for a commodity that
will be delivered later. Buyers and sellers in the futures markets look at current economic
information (supply and demand) and anticipate how it may affect the price of a commodity.
Though not written each future contract specifies the time of delivery or payment, where the
commodity should be delivered, and the quality and quantity of the item. This specificity is
what makes the futures contracts attractive to those who want to plan ahead and protect
themselves from dangerous price swings and to investors wanting to profit from market
fluctuations.
The standard features are called contract specifications. The futures exchange where the
commodity is traded usually provides contract specifications for commodity. Business
journals are one of the best sources for commodity market information.
A common example of how commodity prices may appear is given below:
Friday April 16
Corn (CBOT) 5,000 bushels, centsper bushels
Open High Low Settle Change
May 231 231 227 227 -4
July 236 237 232 233 -4
Sept 241 241 237 237 -3
Dec 246 246 242 243 -3
Name of commodity: corn
Where it is traded: Chicago board of Trade
Contract size: 5,000 bushels
7/27/2019 Commodity Marketing
8/21
Price quote: price per bushel
Open is the first price anyone paid for corn. High is the highest price anyone paid for corn.
Settle or settlement is the last price anyone paid for corn. Change or net change is the
difference between the settlement price today, and the previous trading day.
Practice: July corn opened at.......................... and settles at............... on April 16. Thelowest price anyone paid for July corn, on April 16, was........................., and the
highest price anyone paid for July corn on that day was.................. the contract size is
..............., prices are quoted in........................, and it is traded at the ................
Determining the value of a futures contract
Suppose the settlement price for December corn futures is 200 cents a bushel: that is , $2.00 a
bushel. To calculate the dollar value of one corn contract, multiply the $2.00 settlement price
by the contract size. In the case of CBOT corn futures, each contract equals 5,000bushels of
corn, so if 1 bushel of corn is worth $2.00, then a 5,000 bushel contract is worth $10,000; $
2.00 per bushel times 5,000 bushels equals $ 10,000.
Futures contracts do not always trade in even numbers: sometimes they move in fractions.These fractions are the smallest price unit at which a futures contract trades and are called
minimum price fluctuations. in futures lingo it is referred to as ticks. The tick size of a
futures contract varies according to the commodity.
The minimum price fluctuation for a CBOT corn futures contract, for instance, is cent per
bushel, or $12.50 per contract (5,000 X $.0025).
Keeping in mind that the minimum price fluctuation for CBOT corn futures is 14 cents perbushel, the next few higher prices above corn trading at 200 cents per bushel ($2.00/bu)
would be 200 cents, 200 cents, 200 , and 201 cents. To calculate the value of a futures
contract when fractions are involved, just use the same equation of settlement price times
contract size. For example, if December corn futures are trading at 200 cents /bu. Then the
contract value is
$2.0025/bushel X 5,000 bushels = $ 10,012.50.
7/27/2019 Commodity Marketing
9/21
Determining profit or loss on a futures contract
Suppose you read in the paper that soil moisture in the midlands was below normal for the
month of June and the forecast does not look promising for rain. Limited rainfall during the
growing season could cause the production of corn to decrease, thus increasing the price.
Anticipating higher corn prices, you buy one December corn futures contract at 250
cents/bushels. On July 1, if you were right and corn prices rise, you will make a profit.
Throughout the month of July, there is no rain in the Corn Belt. The end result is higher
prices, so you decide to offset your position on July 30 by selling one December futures
contract at $2.55/bushel.
Did you make a profit or loss? :
Calculation: Jul 1 BUY 1 Dec. Corn futures at $2.50/bushel
Jul 30 SELL 1 Dec. Corn futures at $ 2.55/bushel
Profit $ .05/ bushel
The total profit is $250 ($.05 X 5000 bushel).
** remember that brokerage fees are always subtracted from your profit.
Who participates?
There are two main categories of futures traders that utilize futures contracts. These are the
hedgers and speculators. Hedgers either now own, or will at some time own, the commodity
they are trading. Hedger may be producers, elevator owners, or any others in the agribusinessinput and outputs sectors.
Hedgers
Hedging is a tool used by producers and agribusinesses to shift some of the risk resulting
from price uncertainty to speculators who trade in the futures market. Hedgers use the futures
primarily to reduce their price risks in dealing with the cash commodity. They may speculate
to some extent on the relationship between futures prices and cash prices, but their goal is to
7/27/2019 Commodity Marketing
10/21
avoid the substantial decline or rises in prices often encountered in the commodity market.
Hedging involves taking a position in the futures market equal but opposite to what one has
in the cash market. If prices fall, a producer who placed a hedge will be protected. This is
why hedgers willingly give up the opportunity to benefit from favourable price changes to
achieve protection from unfavourable changes.
Long (buying) and short (selling) hedgers
Two terms used to describe buying and selling are long and short. If you first buy a futures
contract, this is called going long, or going long hedge. If you first sell a futures contract, this
is called going short, or going short hedge. Hedging in the futures market is a two step
process. Depending on your cash market situation, you will either buy or sell futures as yourfirst position. For instance, if you are going to buy a commodity in the cash market at a later
time, your fist step is to buy a futures contract. In contrast, if you are going to sell a cash
commodity at a later time, your first step in the hedging process is to sell futures contracts.
The second stage in the process occurs when the cash market transaction takes place. At this
time, the futures position is no longer needed for price protection, so it should therefore be
offset (closed out). If your hedge was initially long, you would offset your position by selling
the contract back. If your hedge was initially short, you would buy back the futures contract.
Both the opening and closing positions must be for the same commodity, number of
contracts, and delivery month.
Example of a long hedge
A food processor is planning to buy 240,000 pounds of soybean oil over the next few months
to cover production needs. Currently, soybean oil is quoted at 26 cents a pound, but the
company management is concerned that prices will rise by the time it is ready to purchase
and take delivery of the oil. To take advantage of current prices, the company decides to buy
four CBOT September soybean oil futures contracts at 26 cents a pound. The standard
contract size for CBOT soy bean oil is 60, 000 pounds. The managements greatest fear
comes true. The price of soybean oil jumps to 31 cents a pound by the time the food
processor is ready to purchase it. The company offsets its futures position by selling four
CBOT September soybean oil contracts for 31 cents a pound. The companys hedging
activities result in the following:
7/27/2019 Commodity Marketing
11/21
Cash market Futures market
June
Plans to buy 240,000 ibs. Soybean oil in the
cash market at $.26 / ib.
June
Buys 4 CBOT Sept. soybean oil futures
contracts at $.26/ib.
August
Purchases 240,000 ibs. Soybean oil in the
cash market at $.31/ib.
August
Sells 4 CBOT Sept. soybean oil futures
contracts at $ .31/ib.
Purchase price of cash soybean oil $.31/ib
Less futures gain ($.31 - $.26) $.05/ib
Net purchase price $.26/ib
By using CBOT soybean oil futures, the food processor lowered its purchase price from 31
cents to 26 cents a pound. That was exactly what the company expected to pay.
Example of a short hedge
Rather than selling for whatever price the local elevator is willing to pay come harvest time, a
producer decides to explore a variety of marketing alternatives including futures. Her
ultimate goal is to improve her bottom line. Suppose she figures that it cost her $ 2.00 to
produce one bushel of corn. When corn enters a price range of where the producer can make
a profit, she may decide to hedge a portion of her crop by selling one CBOT December corn
futures contract. (The standard contract size for one CBOT corn futures contract is 5,000
bushels)
By early may, CBOT December corn futures hit $ 2.60 a bushel. To lock in a selling price of
42.60, the grain producer sells one CBOT December corn futures contract. As it turns out,
there was a near perfect growing condition that year and corn yields are above normal,
causing prices to drop. By harvest time, corn has fallen to $1.90 a bushel. The producer
therefore offsets her futures position by purchasing one CBOT December corn futures
contract. The corn producers hedging activities result in the following:
7/27/2019 Commodity Marketing
12/21
Cash market Futures market
May
Plans to sell 5,000 bu. Corn in the cash
market at $2.60/bu.
May
Sells one CBOT Dec. Corn futures contract
at $ 2.60/bu.
October
Sells 5,000bu. Corn in the market at $
1.90/bu.
October
Buys one CBOT Dec. Corn futures contract
at $ 1.90/bu.
Sales price of cash corn $ 1.90/bu.
Plus futures gain ($2.60-$1.90) $ 0.70/bu.
Net sales price $ 2.60/bu.
By using CBOT corn futures, the producer increased her final sale price from $1.90 to $ 2.60
a bushel. That was exactly what she wanted to receive. Better yet, the final sale price was 60
cents per bushel higher than her production expenses.
** keep in mind that these examples are simplified to give an overview of hedging.
Speculators
Speculators, in contrast, will likely never own or even see the physical commodity. They are
in the game to profit from a move up or down in the market. Agricultural producers,
commodity processors, exporters, food manufacturers, and others use the futures market to
shift market risk (the risk of adverse price movements) to someone else. The party who
assumes the risk is the speculator. They just buy and sell futures contracts and hope to make a
profit on their expectations and predictions of future price movements. The profit potential of
a speculator is proportional to the amount of risk that is assumed and the speculators skill in
forecasting price movement. Speculators always offset their positions by buying (selling)
futures contacts they originally sold (bought). Speculators take a price risk on a given product
with the hope of making a profit. The risk a speculator takes is not the same as that a gambler
takes in buying a lottery ticket. In contrast to gambling, a commodity speculator assumes a
naturally occurring risk rather than one that is deliberately created. In agribusiness, risk is
7/27/2019 Commodity Marketing
13/21
inherent when one holds inventories of commodities. If speculators were not willing to
assume some of the risk, a producers costs would increase due to losses from adverse prices.
Instead, agribusiness firms are able to produce items at lower costs because they have shifted
some of their natural risk to commodity speculators. With this type of market, society
benefits.
Speculators can be classified by their trading methods:
A position trader: this is a public or professional trader who initiates a futures oroptions position and holds it over a period of days, weeks, or months.
A day trader: holds market positions only during the course of a single tradingsession, and rarely carries a position overnight. Most day traders are exchangemembers who execute their transactions in the trading pits.
Scalpers: trades only for themselves in the pits. Scalpers trade in minimumfluctuations, taking small profits and losses on a heavy volume of trades. Like a day
trader, a scalper rarely holds positions overnight.
Spreaders: trade on the shifting price relationships between two or more differentfutures contracts. Examples include: different delivery months for the same
commodity, the prices of the same commodity on different exchanges, products andtheir by-products, and different but related commodities.
Economic functions of futures markets
Due to the presence of speculations and hedging in futures contracts, futures markets provide
a number of very useful economic functions. They can be enumerated in terms of their role
in:
Enabling hedgers to transfer pri ce risk to speculators: without futures the process ofcommodity marketing will be more risky and inefficient. The importance of futures
can be observed if for whatever reason, futures are not operating. This might be due to
severe weather at the location of the exchange, limit moves in the contract price, etc.
At those times in the grain trade, the comment is often heard that, elevator are taking
protection. This means that being unable to hedge; they widen their margins as they
face increased price risks.
7/27/2019 Commodity Marketing
14/21
Facil itate pri ce discovery: futures markets provide central facilities for buyers andsellers to interact and bring all the forces impinging on price formation together. In
many cases, this is a face to face confrontation of buyers and sellers in octagonal pits
or similar sites. Typically, the trading is by open outcry in a very transparent process.
The floor brokers involved are mainly representing the real buyers and sellers, who
may be from all parts of the world.
Enhancing information collection and dissemination: information needed foreffective use of futures markets is so valuable that many resources are devoted to
collection and dissemination. This involves both public and private organizations. The
ministry of agriculture, national farmers union, agricultural marketing association and
various cooperating counterparts, play a major role in providing comprehensive,
unbiased crop and livestock estimates, and market information. Private consulting
firms and specialised market news services are also prominent. Futures market
themselves collect and make available an extensive amount of data on prices, volume,
and open interest. Open position data on hedgers, small traders and large trades are
also generated and distributed.
Assisting in the coordination of economic activity: another economic function offutures market is to help coordinate economic activity. Futures price information is so
prevalent that commercial houses simply refer to cash prices in terms of their
relationships to futures. This facilitates day to day operations in moving products
through the system. With prices on products and in/or inputs locked in, a firm can
devote more energy into the production line operation and increasing efficiency.
Stabil izing markets and providing liquidity: active future markets are liquid (manybuyers and sellers are ever present either on the trading floor or linked to brokerage
offices). At times, cash markets can be a bit clumsy allowing gluts in supplies to
unduly depress prices. At other times, shortages can move markets above levels
warranted by supply-demand conditions. Some do question whether futures help
stabilise prices and cite examples of high volatility in futures at times. Research on
commodities futures trading supports the contention that futures stabilize markets.
However, in the very short time context, futures may be less stable because market
information can quickly be reflected in price moves as compared to more dispersed
and less coordinated cash markets.
7/27/2019 Commodity Marketing
15/21
Providing fl exibil ity in forward pri cing: Also related to the transfer of risk, futuresmarkets provide commercial operators considerable flexibility in forward pricing both
products and inputs. They can choose to use futures or not and can decide what
proportion of their products and inputs to hedge, determining how much risk they are
willing to assume.
What commodities are traded, where and why?
Futures markets are worldwide. In addition to 13 exchanges in the US, 12 other nations have
futures markets. They include Australia, Brazil, Canada (four), France (three), Hong Kong,
Japan (four), Malaysia, the Netherlands, New Zealand, Singapore, Sweden, and the United
Kingdom (nine).
A wide variety of commodities are actively traded in futures markets. Among agricultural
products are grains, oilseeds, livestock and meat, milk, dairy products, tropical products such
as sugar, coffee and cocoa, frozen orange juice and cotton. A list of some of the commodities
and where they are trade is given below:
List of traded commodities
Agricultural (grains, and food and fibre)
Commodity Main Exchange Contract Size Trading Symbol
Corn CBOT 5000 bu C
Corn EURONEXT 50 tons EMA
Oats CBOT 5000 bu O
Rough Rice CBOT 2000 cwt RR
Soybeans CBOT 5000 bu S
Rapeseed EURONEXT 50 tons ECO
Soybean Meal CBOT 100 short tons SM
Soybean Oil CBOT 60,000 lb BO
Wheat CBOT 5000 bu W
Cocoa NYBOT 10 tons CC
Coffee C NYBOT 37,500 lb KC
Cotton No.2 NYBOT 50,000 lb CT
Sugar No.11 NYBOT 112,000 lb SB
Sugar No.14 NYBOT 112,000 lb SE
http://en.wikipedia.org/wiki/Bushelhttp://en.wikipedia.org/wiki/Bushel7/27/2019 Commodity Marketing
16/21
Livestock and meat
Commodity Contract Size Currency Main ExchangeTrading
Symbol
Lean Hogs
40,000 lb (20tons) USD ($)
Chicago MercantileExchange LH
Frozen PorkBellies
40,000 lb (20tons)
USD ($)Chicago MercantileExchange
PB
Live Cattle40,000 lb (20tons)
USD ($)Chicago MercantileExchange
LC
Feeder Cattle 50,000 lb (25tons)
USD ($)Chicago MercantileExchange
FC
The following agricultural products are not, at present (2008), traded on any exchange, and,
therefore, no spot or futures market where producers, consumers and traders can fix an
official or settlement price exists for these minerals. Generally the only price information that
is available is based on information from producers, consumers and traders.
Fresh Flowers, Cut Flowers, Melons,Lemons,Tung Oil,Gum Arabic, Pine Oil,Xanthan,
Milk, Tomatoes, Grapes, Eggs, Potatoes, and Figs.
Others
Commodity Unit Currency Bourse
Ethanol 29,000 US gallon(110 m)
USD ($) CBOT
Rubber 1 kg US cents ()*Singapore CommodityExchange
Palm Oil 1000 kgMalaysian Ringgit(RM)
Bursa Malaysia
Wool 1 kg AUD (p) ASX
Polypropylene 1000 kg USD ($) London Metal Exchange
Linear Low DensityPolyethylene (LL)
1000 kg USD ($) London Metal Exchange
And so many more
In reviewing the list of commodities traded in futures markets, certain common
characteristics are apparent:
1. Pri ces are volati le: volatility attracts both speculative and hedger interest. Speculatorscan profit (or lose) in a volatile market, but has little opportunity for profit in a stable
http://en.wikipedia.org/wiki/Lean_Hogshttp://en.wikipedia.org/wiki/Lean_Hogshttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/United_States_currencyhttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Pork_bellyhttp://en.wikipedia.org/wiki/Pork_bellyhttp://en.wikipedia.org/wiki/Pork_bellyhttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Cattlehttp://en.wikipedia.org/wiki/Cattlehttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/w/index.php?title=Feeder_Cattle&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Feeder_Cattle&action=edit&redlink=1http://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Flowerhttp://en.wikipedia.org/wiki/Melonhttp://en.wikipedia.org/wiki/Lemonhttp://en.wikipedia.org/wiki/Tung_Oilhttp://en.wikipedia.org/wiki/Gum_Arabichttp://en.wikipedia.org/wiki/Pine_Oilhttp://en.wikipedia.org/wiki/Xanthanhttp://en.wikipedia.org/wiki/Milkhttp://en.wikipedia.org/wiki/Tomatoeshttp://en.wikipedia.org/wiki/Grapeshttp://en.wikipedia.org/wiki/Egg_%28food%29http://en.wikipedia.org/wiki/Potatoeshttp://en.wikipedia.org/wiki/Figshttp://en.wikipedia.org/wiki/Ethanolhttp://en.wikipedia.org/wiki/Ethanolhttp://en.wikipedia.org/wiki/United_States_currencyhttp://en.wikipedia.org/wiki/United_States_currencyhttp://en.wikipedia.org/wiki/Rubberhttp://www.sicom.net/http://www.sicom.net/http://en.wikipedia.org/wiki/Palm_Oilhttp://en.wikipedia.org/wiki/Malaysian_Ringgithttp://en.wikipedia.org/wiki/Bursa_Malaysiahttp://en.wikipedia.org/wiki/Bursa_Malaysiahttp://en.wikipedia.org/wiki/Bursa_Malaysiahttp://en.wikipedia.org/wiki/Woolhttp://en.wikipedia.org/wiki/ASXhttp://en.wikipedia.org/wiki/Polypropylenehttp://en.wikipedia.org/wiki/Polypropylenehttp://en.wikipedia.org/wiki/London_Metal_Exchangehttp://en.wikipedia.org/wiki/London_Metal_Exchangehttp://en.wikipedia.org/wiki/Polyethylenehttp://en.wikipedia.org/wiki/Polyethylenehttp://en.wikipedia.org/wiki/London_Metal_Exchangehttp://en.wikipedia.org/wiki/Polypropylenehttp://en.wikipedia.org/wiki/ASXhttp://en.wikipedia.org/wiki/Woolhttp://en.wikipedia.org/wiki/Bursa_Malaysiahttp://en.wikipedia.org/wiki/Malaysian_Ringgithttp://en.wikipedia.org/wiki/Palm_Oilhttp://www.sicom.net/http://www.sicom.net/http://en.wikipedia.org/wiki/Rubberhttp://en.wikipedia.org/wiki/United_States_currencyhttp://en.wikipedia.org/wiki/Ethanolhttp://en.wikipedia.org/wiki/Figshttp://en.wikipedia.org/wiki/Potatoeshttp://en.wikipedia.org/wiki/Egg_%28food%29http://en.wikipedia.org/wiki/Grapeshttp://en.wikipedia.org/wiki/Tomatoeshttp://en.wikipedia.org/wiki/Milkhttp://en.wikipedia.org/wiki/Xanthanhttp://en.wikipedia.org/wiki/Pine_Oilhttp://en.wikipedia.org/wiki/Gum_Arabichttp://en.wikipedia.org/wiki/Tung_Oilhttp://en.wikipedia.org/wiki/Lemonhttp://en.wikipedia.org/wiki/Melonhttp://en.wikipedia.org/wiki/Flowerhttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/w/index.php?title=Feeder_Cattle&action=edit&redlink=1http://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Cattlehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Pork_bellyhttp://en.wikipedia.org/wiki/Pork_bellyhttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/United_States_currencyhttp://en.wikipedia.org/wiki/Pound_%28mass%29http://en.wikipedia.org/wiki/Lean_Hogs7/27/2019 Commodity Marketing
17/21
market. Hedgers need protection in a volatile market, but have no need for such
protection in a stable market.
2. Products are standardized. Grading is established: because trading in futures marketsfocuses on a base grade, with the possibility of delivery, the product must have grades
and standards acceptable to the industry. This is particularly important with
agricultural commodities that are not easily produced to a particular standard.
3. Products are actively produced and marketed: products broadly produced andmarketed have a better chance of success as actively traded commodities than those
with concentrated production areas with few marketing channels. For example, live
cattle futures succeeded, but beef carcass did not, ostensibly because live cattle had a
broad production base while beef carcass production was much more concentrated.
4. Many products are storable: at one time, storability was felt to be a primeconsideration. Reasons for this related to the delivery process. However, the
continuance of live cattle, feeder cattle, and hog futures is testimony that storability is
not a necessary condition. However, very perishable products such as fresh fruits and
vegetables are not viable candidates.
Options on futures
In contrast to futures, options on futures allow investors and risk managers to define risk and
limit it to the cost of a premium paid for the right to buy and sell a futures contract. Options
provide the opportunity but not the obligation to sell or buy a commodity at a certain
price. When talking about options, the underlying commodity is a futures contract and not the
physical commodity. With an option, producers have the right, but not the obligation to buy
or sell a specific commodity within a specific period of time at a specific price. Producers can
use options contracts to establish a minimum selling price for their produce while still
retaining the right to any price increase.
Futures options are much more attractive to many hedgers and speculators than straight
futures contracts. (House example).
Example of a simplified options contract: consider a call option that conveys the right to buy
a used combine from your neighbour. You are debating whether to buy a used combine or to
7/27/2019 Commodity Marketing
18/21
put up capital for a new combine. You convince your neighbour to sell you an option to
purchase the combine at any time before April 1. In turn, the neighbour gives you the right to
buy the used combine for $ 10,000. For this right, you pay $2,000.
In option terms, the combine is the underlying commodity, and $10,000 is the stri ke pri ce.
April 1 is the expiration date, and the $2,000 you paid for the option is the premium. At any
time before the expiration date, your option contract gives you the right to exercise your
option and purchase the combine. However, you are not obligated to buy the combine. You
may choose to not exercise your option-you can simply let your option expire. You may
offset your current position by selling your option to someone else. Whatever measure you
take, the writer(seller) of the option keeps the $2,000 premium. With options, once you
make a transaction, you can predict your maximum losses.
A call is an option that gives the option buyer the right (without obligation) to purchase a
futures contract at a certain price on or before the expiration date of the option, for a price
called the premium which is determined in open-outcry trading in pits on the trading floor.
A put is an option that gives the option buyer the right (without obligation) to sell a futures
contract at a certain price on or before the expiration date of the option.
The premium is the cost of futures options. It is the only variable in the options contract
traded on the trading floor. The premium depends on market conditions such as volatility,
time until the option expires, and other economic variables. The premium is the only element
of an option contract that is negotiated in the trading pit; all the other parts of an option
contract- such as the strike price and expiration date- are predetermined or standardized by
the trading board.
Factors affecting premiums
Intrinsic value: the intrinsic value of an option is the positive difference between thestrike price and the underlying futures price.
For a put, the intrinsic value is the amount that the strike price exceeds the futures
price. For example, when the July corn futures price is $2.50, a July corn put with a
strike price of $2.70 has an intrinsic value of 20 cents a bushel. If the futures price
7/27/2019 Commodity Marketing
19/21
increases to $2.60, the options intrinsic value declines to 10 cents a bushel. If the
strike for a put is below the futures, the intrinsic value is zero, not negative.
For a call, the intrinsic value is the amount that the strike price is below the futures
price. For example, when the December corn futures price is $2.50, a December corn
call with a strike price of $2.20 has an intrinsic value of 30 cents a bushel. If the
futures price increases to $2.60, the options intrinsic value increases to 40 cents a
bushel. If the futures price declines to $2.40, the intrinsic value declines to 20 cents a
bushel
Time value: time value originates from the fact that the longer the time untilexpiration, the more the opportunity for buyers and sellers to profit. Time value-
sometimes called extrinsic value- reflects the amount of money that buyers are willing
to pay hoping that an option will be worth exercising at or before expiration. For
example, if July corn futures are at $2.16 and a July corn call with a strike price of $2
is selling for 18 cents, then the intrinsic value equals 16 cents (the difference between
the strike price and futures price) and the time value equals 2 cents (difference
between the total premium and the intrinsic value).
The time value of an option declines as the expiration date of the option approach.
The option will have no time value at expiration, and any remaining premium will
consist entirely of intrinsic value. Major factors affecting time value include the
following:
Time remain ing until expir ation: the greater the number of days remaininguntil expiration, the greater the time value of an option will be. This occurs
because option sellers will demand a higher price because it is more likely that
the option will eventually be worth exercising
Market volatili ty: time value also increases as market volatility increases.Again, option sellers will demand a higher premium because the more volatile
or variable a market is, the more likely it is that the option will be worth
exercising.
I nterest rate:although the effect is minimal, interest rates affect the timevalue of an option: as interest rates increases, time value decreases.
7/27/2019 Commodity Marketing
20/21
Determining option classification
Call option Put option
Inthemoney Futures price > strike price Futures price > strike price
Atthemoney Futures price = strike price Futures price = strike price
Outofthe - money Futures price < strike price Futures price > strike price
Ways to exit a futures option position
Once an option has been traded, there are three ways you can get out of a position: exercise
the option, offset the option, or let the option expire.
Exercise: only the option buyer can decide whether to exercise the option. When anoption position is exercised, both the buyers and the seller of the option are assigned a
futures position. The option buyer first notifies his/her broker, who then submits an
exercise notice to the board of trade clearing corporation. The exercise is carried out
that night. The clearing corporation creates a new futures position at the strike price to
a randomly selected customer who sold the same option. The entire procedure is
carried out before trading opens on the following business day.
Offsetting: offsetting is the most common method of closing out an option position.You do this by purchasing a put or call identical to the put or call you originally sold:
or by selling a put or call identical to the one you originally bought. Offsetting an
option before expiration is the only way you can recover any remaining time value.
Offsetting also precludes the risk of being assigned a futures position if you originally
sold an option and want to avoid the possibility of being exercised against. Your net
profit or loss, after a commission is deducted, is the difference between the premium
you paid to buy the option and the premium you receive when you offset the option.
Market participants always face the risk that there may not be an active market for
their particular options at the time they choose to offset, especially if the option is out
of the money or the expiration date is near.
Expiration: the other choice you have is to let the option expire by simply doingnothing. In fact, the right to hold the option up until the final day for exercise is one of
the features that make options attractive to investors. Therefore, if the change in price
initially moves in the opposite direction, you have the assurance that the most you canlose is the premium you paid for the option.
7/27/2019 Commodity Marketing
21/21
Group Assignment
1. Some say speculating is the same as gambling. Others say that speculating is acalculated business decision. Which view do you favour? Write an essay defending
your position.
2. If you decided to trade futures commodities as either a hedger or a speculator, wouldyou trade futures contracts or futures options? Defend your choice.
This group assignment will be presented to the class along with other students, in the form of
a debate.