The soft markets are made of cocoa, coffee, cotton, frozen concentrated orange juice and sugar, some of the oldest commodities still around today. You trace their roots as commerce back over 3000 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. Any investor could potentially lose more than originally invested.
What are soft futures contracts?
An soft futures contract is a legally binding agreement for delivery of cocoa, coffee, cotton, frozen concentrated orange juice and sugar in the future at an agreed upon price. The contracts are standardized by NYBOT as to quantity, quality, time and place of delivery. Only the price is variable.
Most futures contract 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 shorted on a down tick, which gives market participants greater flexibility. This flexibility provides hedgers with an ability to protect their physical position and for speculators to take a position based on market expectations.
Since the soft commodity markets are traded at an exchange, the clearing services ensure no default risk. This means that the exchange acts a buyer to every seller should a market participant have to default on their responsibilities.
Market Personality
These markets are usually a bit lower in volume than you will find elsewhere, as in the energies or indices. With this decrease in volume, one of two things can happen: either the market will be flat or a little volume can push a market very quickly. This tends to happen with more frequency in this complex. I would encourage any investor looking at trading these markets to be fully educated before getting in. I have seen more than one trader lose his shirt in coffee.
With the merger of the NYBOT and ICE, these markets will soon be going electronic. And if history has been any indication, a pick up in the volume should be coming.
Contract Specifications
Although there are other sugar and coffee contracts trade around the world, this piece deals only with those traded at NYBOT.
Cocoa
Discovered by the natives of Central America over 3000 years ago, cocoa was originally a luxury for very rich. Today, most of the world’s cocoa is grown in a handful of countries: 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 $1500/M ton, the contract has a total value of $15,000. If a trader is long at $15000/M ton, and the markets move to $1555/bl, that is a move of $550 ($1500 – $1555 = $55, 55 x 10 M ton. = $550).
The minimum price movement or tick size is a dollar. Although the market frequently will trade in sizes greater than a dollar, one-dollar 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.
Coffee
Coffee was originally discovered in Ethiopia over 2000 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 and outside the Arabian borders.
Coffee is trade in cents per pound. One contract of coffee controls 37,500 pounds of coffee.. When the price of coffee is trading at $1.00/lb, the cash value of that contract will be $37,500 ($1.00 x 37,500 = $37,500).
The tick size is $0.005 per pound, which equates to $18.75 per tick. For example, if one were to go long at $1.10 and the markets moved to $1.1550, one would have a profit of $2062.50 ($1.1550 – $1.10 = $0.0550, $0.0550 x 37,500 = $2062.50).
Since it one of the larger contracts in dollar terms, little movements have a big impact on price. Coffee has one of larger daily ranges of all the softs therefore making it very volatile.
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.
Cotton
Since cotton has universal appeal and can used in many different products, cotton has been one of more influential commodities. Discovered over 5000 years ago, cotton has played a vital role in the rise and fall of many countries. And 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 $0.53/lb, the contract will have a value of $26,500 ($0.53 x 50,000 lbs. = $26,500).
The minimum tick size is $0.0001 or $5.00. So any 2-cent move in cotton will equate to either a gain or a loss of $1000. When the price of cotton exceeds $0.95/lb (which hasn’t happened in over ten years), 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.
Frozen Concentrated Orange Juice
Orange Juice is relative newcomer to the commodity markets. For centuries, OJ was consumed as fresh fruit since 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 become the industry standard.
One contract of FCOJ equals 15,000 pounds. If the current market price is $0.90 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 $0.95, and then sells it $1.00. In this transaction, you would have made $750 on the $0.05 move in FCOJ.
Oranges of origins 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.
Sugar
It is widely believed that humans first used sugar well over 2000 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 trade 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 $11704 ($0.1045/lb x 112, 000 lbs. = $11,704). If the market moves from $0.1000 to $0.1240, that is equivalent to a dollar move of $2688.
The minimum price movement for sugar is $0.0001 or $11.20.
Sugar is only deliverable in March, May, July and October. There are delivery points are in each nation where the sugar is produced, which is 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.
Conclusion
There are many different opportunities in the soft commodity market. Any person looking to invest should carefully consider the risk involved and be aware of the contract specifications before investing.