Sugar Futures and Sugar Options
Market
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Futures E Guide
Dear clients and students of the commodity markets, the
following information should answer all of your questions about Sugar Futures
and Options. You may also call 800-915-4716 or email
tkfutures@earthlink.net your sugar future
and sugar options questions to be answered by a seasoned professional.
The History of Sugar and Sugar Futures Trading
For centuries, sugar has been a highly valued and widely traded commodity. Sugar
cane production originated, according to historians, some 2,500 years ago on the
Indian subcontinent. Today, sugar is a basic part of the production and
consumption of many foods worldwide which has made sugar futures very
necessary to hedge production and consumption price risk.
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The September 11 terrorist attack destroyed the CSCE that was located in the
World Trade Center in New York City. It was moved a nearby site and sugar
future
and sugar option trading were fully functional within within a few days after
its destruction. It is a testament to the viability and strength of the futures
markets. The Coffee, Sugar, and Cocoa Exchange merged with the (NYBOT) and again
with the (ICE) and is the premiere world market for the trading of coffee, sugar
and cocoa futures and options, and since 1993. Three sugar futures contracts (world
raw, world refined, and domestic raw) are listed at the (ICE). In 1982, the CSCE
launched the nation's first exchange-traded option on a futures contract when it
introduced options on world sugar futures.
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Sugar Economics
Most sugar is either consumed in the country where it is produced under
government controlled pricing arrangements or moved from one country to another
under long-term supply agreements. The sugar not subject to such agreements is
freely traded among a number of nations, corporations and individuals. This
makes the market for sugar a "residual" market - a market in which freely traded
sugar is only a fraction of worldwide production. Since the free market may be
only 20-25% of world production, a small change in production or consumption can
translate to a much larger change in free market sugar supply. The delicate
supply/demand balance is a main reason for sugar futures prices/ historical
price volatility.
Supply
There are two main types of sugar grown in the world: cane and beet. Both
produce the identical refined sugar product. Sugar cane is a bamboo-like grass
grown in semi-topical regions. It accounts for about 70% of world production.
Beet sugar comes from the sugar beet plant, which grows in temperate climates
and accounts for the balance of world production. Intemperate weather, disease,
insects, soil quality and cultivation affect both cane and beet production, as
do trade agreements and price support programs.
India, Brazil, China, Thailand, Cuba and Mexico are among the leading
sugar cane producers. European Union nations, the Russian Federation and Ukraine
produce the majority of all sugar beets. The European Union, Brazil, Thailand,
Australia, Cuba and Ukraine are leading sugar exporters.
U.S. sugar cane is grown in Florida, Louisiana, Hawaii,
Texas and Puerto Rico. Beet sugar is grown in 14 states, with Minnesota, Idaho,
North Dakota and California leading production.
The sugar industry closely monitors the level of sugar stocks relative to sugar
consumption as a measure of available supply. In the past, small changes in the
ratio have led to large sugar futures price movements in the opposite direction.
Demand
Industrialized nations account for most sugar consumption. The European Union,
Russian Federation, United States, China and Japan are among the worlds largest
sugar importers.
An imbalance between world consumption and
production in 1980 again sent sugar futures prices skyward - from around 15
cents per pound at the beginning of the year to about 45 cents per pound in the
fall. By 1982, however, sugar futures prices had fallen back to their 1977-79 range, averaging
over 8 cents per pound for the year. Ample supplies and an evolving
geo-political scene have led to prices in the 2 cents/pound to 16 cents/pound
range since then.
Beyond price, other factors influencing sugar demand include: refinery activity;
consumer income; candy and confectionery sales; changing eating habits; and
sugars use in new technologies, such as ethanol production for automobile fuel.
Many South American countries use sugar and corn based ethanol in their unleaded
gasoline and diesel engines. An unexpected increase in demand can lead to much
higher sugar futures prices.
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The Role of the Exchange
Since all sugar futures and options contracts are standardized (with delivery
months and locations, quantity and grade constant), only price is negotiable.
These prices are determined by "open outcry" trading on the exchange floor. With open outcry, all market participants are afforded
the opportunity to buy or sell at the best available current price.
All trading activity is closely monitored by the Exchange according to
guidelines established by the CFTC. The Exchange is committed to maintaining
markets of the highest quality. To help fulfill this self- regulatory mandate,
the ICE employs advanced technological systems to perform a variety of
surveillance and compliance procedures.
Trading Sugar Options
In 1982, the CSCE introduced options on world
(#11) sugar futures - the nation's first exchange -traded option on commodity
futures. Because options strategies are numerous and can be tailored to meet a
wide array of risk profiles, time horizons and cost considerations, hedgers and
investors have increasingly realized the vast potential of sugar futures options.
Buyers
Option buyers obtain the right, but not the obligation, to enter the underlying
sugar futures market at a predetermined price within a specific period of time. A
"call" option confers the right to buy (go long) sugar futures, while a "put"
options confers the right to sell (go short) sugar futures. The predetermined
price is known as the "strike" or "exercised" price, and the last day when an
option may be exercised is the "expiration Date". Buyers pay sellers a premium
for their rights.
Because an option holder is under no obligation to enter the sugar futures
market, losses are limited to the premium paid. There are no margin calls. If
the underlying sugar futures market moves against an options position, the
holder can simply let the option for the sugar futures expire worthless. After all, the
holder of an option to buy sugar at 13.00 cents per pound (call option) probably
won't be interested in exercising the option if the then-current market price is
10.00 cents per pound. On the other side, potential gains are unlimited, net of
the premium cost.
Being able to participate in the market at a known cost with essentially
unlimited profit potential has made the purchase of straight call and put
options popular among sugar futures investors. The same features allow hedgers to guard
against adverse price movements at a known cost without foregoing the benefits
of favorable price movements. In an options hedge, gains are only reduced by the
premium paid - unlike a sugar futures hedge, where gains in the cash market are
more wholly offset by sugar futures market losses.
Option holders can exit their position in one of three ways: exercise the option
and enter the futures market; sell the options back in the market (at a profit
or loss depending on the difference between purchase and sell price); or let the
option expire worthless.
Sellers
Option sellers, or "writers", receive a premium for granting option rights to
buyers. In exchange for the premium, writers assume the risk of being assigned a
position opposite that of the buyer in the underlying sugar futures market at
any time prior to expiration. Writers of call options must be prepared to assume
short positions at the option's strike price at the option holder's discretion,
while put option writers may be assigned long sugar futures positions.
Writing put and call options can serve as a source of additional income during
relatively flat market periods. Because option writers must be prepared to enter
the sugar futures market at any time upon exercise, they are required to
maintain a margin account similar to that for sugar futures positions. Sellers
can offset their positions by buying back their options in the market.
Strike Prices
Traders agree on premiums in an open outcry auction similar to that for sugar futures
contracts. The Exchange generally lists several strike prices for each option
month: one at or near the sugar futures price and a series above and below. As sugar
futures prices rise or fall, higher or lower strike prices are introduced
according to a present formula.
Premiums
A number of factors impact premium levels in
the market. Intrinsic value
is the dollars and cents difference between the option strike price and the
current sugar futures price. An option with intrinsic value has a strike price
making it profitable to exercise and is said to be "in-the-money" (strikes below
futures price for calls, above for puts). An option not profitable to exercise
is "out-of-the-money" (strikes above sugar futures price for calls, below for
puts). "At-the-money" options have strike prices at or very near sugar futures prices.
In general, an option's premium is at least equal to intrinsic value (the amount
by which it is "in-the-money") "Time value" is the sum of money buyers are
willing to pay for an option over and above any intrinsic value the option may
presently have. Time value reflects a buyer's anticipation that, at some point
prior to expiration, a change in the futures price will result in an increase in
the options value. The premium for an "out-of-the-money" option is entirely a
reflection of its time value.
Premiums are also affected by volatility in the underlying sugar futures market.
Because high levels of volatility increase the probability an option will become
valuable to exercise, sellers command larger premiums when markets are more
volatile. Finally, premiums are affected by supply and demand forces and
interest rates relative to alternative investments.
Option Months
Regular options trade on sugar futures contracts having March, May, July and
October delivery periods as well as a January expiration option which is based
upon the March sugar futures contract. Serial options are short-life options contracts
providing additional option expirations on existing sugar futures contracts.
In general, the last trading day for sugar
options is the second Friday of the month proceeding the stated futures month.
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Example: Buying a Sugar Call
Buying a call can be employed to profit from, or achieve protection against, an
increase in the price of sugar. Except for the cost of the option, the profit
potential is similar to having a long position in the underlying sugar futures
contract. Moreover, this strategy may provide greater "staying power" in the
event of a temporary price setback than having an outright long sugar futures
position - there are no margin calls because one cannot lose more than the
premium paid for the option.
For example, assume that in August an investor expects sugar futures prices to
increase by late winter. With March futures trading at 12.00 cents/pound, the
investor decides to purchase a March 12.00 call (an at-the-money option) for
0.75 cents/pound. Since each contract represents 112,000 pounds of sugar, the
total premium paid is $840.
The maximum loss the holder of a long call can incur is the premium paid,
regardless of how far the underlying sugar futures prices fall. The potential
profit is unlimited, however, since the option holder gains dollar-for-dollar in
the rise of the underlying sugar futures price minus the cost of the premium.
Out-of-the-money options do not gain dollar-for-dollar on the rise of the sugar
futures price.
Call options can be purchased for price protection as well as for the pursuit
of trading profits. Commercial firms buying call options effectively establish a
maximum purchase cost equal to the exercise price of the option plus the option
premium. Employed in this way, options offer hedgers price "insurance", while at
the same time allowing them to benefit from price declines since they can allow
the option to expire unexercised.
Example: Buying a Sugar Put
Whereas buyers of calls can profit from rising prices, buyers of put options -
rights to sell sugar futures contracts at the option exercise price - can profit
from price declines. Except for this difference the properties of puts and calls
are the same.
To realize a profit at expiration, the
underlying sugar futures price must be below the option exercise price by an
amount greater than the premium paid for the option. If it is higher, a portion
or the entire premium will be lost. In no case, however, can losses exceed the
premium paid.
For example, the sugar futures investor in May expecting depressed sugar prices
at autumn's onset can purchase October puts. With October sugar futures trading
at 12.00 cents/pound, the investor purchases an October 12.00 put for 0.65
cent/pound (0.65 cent x 112,000 pounds = total of $728/contract).
The sugar futures investor can lose no more than the premium paid, plus
commissions and fees no matter how high sugar futures prices climb. On the other
hand, if prices decline, the investor can realize substantial gains. A sugar futures
sale at the strike price would have similar profit opportunities in a falling
market - plus the premium paid to obtain the option. Losses from a short sugar
futures position, however, would be unlimited in a rising market.
Commercial firms can purchase put options against inventory as "insurance"
against price decreases. The firm may choose the cost or "deductible" for the
insurance by selecting either in-the-money, at-the-money, or out-of the- money
puts. For example, say an October 10.00 put would cost 0.08 cent/pound and an
October 11.00 put cost 0.27 cent/pound in May when futures were trading at 12.00
cents/pound. The 11.00 put would provide 1.00 cent/pound less protection than
the 10.00 put, but it could be obtained at a lower cost.
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