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Arabica Coffee

cafe

1. What is it?

It is possible to trade with coffee future at BM&F. The object os the crude coffee grain – coffea arabica – produced in Brazil, type 4-24 (4/5) or “hard drinking”, for delivery in São Paulo, SP, Brasil.

Trading occurs in sacks, each one with 60 kg of net weight, and quoted in  US dollars. The minimum lot (1 contract) is equal to 100 sacks, or 6 tonnes of arabian coffee. Physical deliveries are possible, but for such the buyer must meet BM&F rules, by filling a document that seals his intention of physically exercise the commodity (AILE). The coffe must meet all requirements proposed by BM&F. Physical executions also imply into transport, freight and other costs. However, if the investor is not looking for a proper delivery, notes will be financially liquidated by the expiry date (most cases).

Coffee futures market was firstly created to guarantee a fair price for sacks, either to sellers or buyers, offering some protection for dealers within this market. Futures trading assures fair pricing for coffee in an specific period in the future. Thus, producers can get better prices for their products, covering costs and making profits. On the other corner, buyers can find coffee at a relatively predictable pricing, making more precise forecasts on their input needs.

As Brazil figures as the world’s largest coffee exporter, coffee futures are extremely relevant for both producers and processors. The coffee market is known for its volatility and high liquidity.

This way, by trading futures producers can assure a fair pricing for their output, and are able to cover costs of plantation, harvest and others, and also make profits. Processors can also maintain their profit margins and have access to more competitive prices.

Coffee futures market change according to the scenario in the physical market, and also as the expiry date comes. Pricing changes also reflect weather conditions, like rain intensitity, as well as terrain conditions, given that both factors can affect quality and volume of the crop. Also, the harvest period influences prices – the closer we are from that, the lower tend to be the prices. The main indicator for coffee prices in the physical market is ESALQ’s index.

As coffee futures are actually traded in dollars, one who is investing in them must follow the PTAX daily exchange rates for finding the value to be executed in BRL by the expiration date.


2. Characteristics

Terminology

Coffee futures trading code is found as follows:

1. Futures code for coffe – “ICF”.

2. The letter corresponds to the expiry month, as follows:

Month Letter
March H
May K
July N
September U
December Z

*International standards

3. Expiry year.

Example: for dealing with coffee futures expiring by May 2014, we have the following code:

ICF K 14

Contract

Coffee futures have the following characteristics:

Object Crude coffee in grains, Brazilian production, coffea arabica species type 4-25 (4/5) or better, hard
drinking
Trading code ICF
Trading unit 100 sacks with 60 kg net
Quotation US dollars per sack of 60 kg net
Minimal Quotation Change US$ 0.05 per sack of 60 kg net
Maximum Quotation Change 9% on the price of the maturity previous day’s settlement negotiated
Standard Lot 1 Contract
Position Limits 1,100 contracts or 25% of opened positions for each expiring date
Trading Timetable 9am – 2h35pm (Regular trading) – 3h30pm – 6pm (After Market)
Last trading day 6th business day preceding the last day of contract expiration

Day trade

It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of ICF futures. However, a day trade is forbidden if happening in the day that the contract expires. The settlement of day trades is performed automatically on the first business day following the date of closing of the business.

Daily Settlements

The daily change is nothing more than a mechanism used by BMF&Bovespa to balance the investor accounts. As futures change in a daily basis, generating credits or debts, investors are daily updated on their positions, earning or losing as prices change – in other words, they either get their profits or pay for their losses daily. The mechanism is a protection against any noncompliance among investors.

For ICF contracts, the daily adjustment happens the day after the deal, or D+1. However, on the expiry date only, updates are made in the same day, or D+0.

Guaranty Margin

It is a value deposited in cash or notes which will covering any noncompliance of an investor in daily adjustments. Usually to operate options, the investor is forced to deposit a guarantee to mitigate risks. The margin is defined by the stock exchange, according to the analysis of the futures market.

The assets accept as guarantee include cash, gold, government or private bonds, letters of pledge and quotes at funds.

For Arabica Coffee Futures Contracts, you must contribute a margin of approximately 4.88% of the trading volume, this value being updated daily as criteria for determining margin for futures contracts.

Operational costs

Costs from trading Arábica Coffe futures are:

Brokerage – it can change depending on the broker. However, most of them use the basic operational fees, stipulated by Bovespa. In this case, costs reach 0.30% for regular operations and 0.07% for the day trade, based on the theoretical redeem value.

Stock exchange fees – that includes emoluments and registering fees by BM&F, charged as follows:

Emoluments: The fees charged by the BMF values ​​related to trading services. They focus on contract negotiation (opening or closing position before maturity), exercise of options, registration and early settlement and assignment of rights procedure. On ICF futures contracts, the fees are charged according to the following table:

Number of contracts Range value
From To US$
1 5 0,41
6 10 0,39
11 20 0,37
21 100 0,35
101 200 0,33
Over 200 0,28

Liquidation charge: this charge regards to the liquidation of the contracts by the expiry, on top of clearing expenses. Usually, this charge is a fixed value, and has nothing to do with the volume of contracts negotiated. For coffee contracts it reaches 0,45% of the total invested amount.

Clearing fees: include all costs for following positions and receiving reports and filings made by the clearing house, as well as operational costs for holding inactive positions on derivatives. It affects all positions opened in contracts traded in the primary market (except for options and minicontracts) and OTC contracts. The fees are daily updated, and charged in the last work day on each month, by closing the positions or every time an investor transfers all positions to another one.

Fees are based in the number of positions opened by the calculation day, and can vary depending on the volume of contracts traded.

For ICF trading, fees reach US$ 0.0055532 per contract and day.

Registry charge: a value charged to register the operation on the clearing house, that only applies to deals that open or close positions before the expiry date, and charged one day after those events.

The table of prices for registration is disclosed by the stock exchange based on average deals for the latest 21 trading sessions. Calculations are made in the last trading session of a week, and define registration charges for the following week.

Currently, registration charges for ICF futures are estimated as follows:

Number of contracts Range value
From To US$
1 5 0,31
6 10 0,29
11 20 0,27
21 100 0,26
101 200 0,24
Over 200 0,22

Maturity

The maturity of the futures contract Arabica Coffee occurs only in some months of the year. The expiration months are March (H), May (K), July (N), September (U), and December (Z). Contracts are negotiated until the sixth preceding the last business day of the delivery month contract working day. It is possible to liquidate the position before maturity, performing the opposite operation, ie if you bought, just sell the same amount, and vice versa.

Liquidation

By the expiration date, all positions that remain opened, after a last adjustment, wil be financially executed by the stock exchange, by registering the inverse operation of the position held. It is possible the investor exit the position before the maturity date, only by performing a counter that it is positioned operation. If it is purchased at Arabica Coffee futures contracts, just only sell these contracts. If sold, just buy, always in the same amount.

Mini Contract

In general, to operate with coffee high investments are necessary, either to the initial margin or the investment itself. The solution found to attract small investor was creating a mini contract for coffee, traded by BM&F.

Rules and features for ‘mini’ coffee futures remain the same as the original contract’s, but minis comprise a 10 sacks deal instead of 100 sacks like the parent contract.

The advantage for trading with mini coffee futures is the lower capital involved, as well as a smaller traded volume, which leads to lower maintenance costs and taxes, and open this market to any smaller investor or producer.

Terminology for mini contracts of coffee follows the pattern below:

1. Trading code for mini coffee futures is “WCF”.

2. The letter corresponds to the expiry month, as follows:

Month Letter
March H
May K
July N
September U
December Z

*International standards

3. Expiry year.

Example: for dealing with mini coffee futures expiring by July 2014, we have the following code:

WCF N 14

The default lot for mini coffee futures is 1 contract. Rules for initial margins, daily updates, liquidation, expiration and taxes are the same as the tradional contract’s.

Operational costs, however, are smaller. Brokers usually grant discounts for mini coffee, especially for day trade operations. There is also the settlement rate and fees, but also with discounts.

Roll over

Roll over operations on coffee – CR1 – comprise the strategy of dealing with two different expiration dates of Arábica Coffe futures at the same time.

Procedures and rules remain the same as regular contracts. However, for CR1 deals, instead of generating new positions in a new contract, it will be automatically transformed in two different operations: the first will have the expiry date set up as being the WCF’s original date (short leg), and the second fixed for expiration in the CR1’s set up date (long leg). Thus, the CR1 will not have open positions at the end of the day, being distributed on their business maturing futures contract Arabica Coffee.


3. Profitability and risks

Making profits from investing in coffee futures is something that depends directly on changes at the coffee spot and futures markets. Such change can be motivated by a serie of factors, peaks of demand or supply for a period, or the other way round. If the investor buys a coffee contract and prices drop, he loses money, which equally happens when he sells a contract and prices go up thereafter.

The Arabica Coffee futures contracts are widely used to hedge, ie, to protect the future price of Arabica Coffee, which could affect coffee producers and companies that need that product to promote their activities, such as food companies and industries.


4. Taxation

Taxes over ACF futures follow the same logic of any other variable income investment. Income tax is equal to 15% of the sum of all daily adjustments (if positive) and is charged just when you close a position. Also, income withholding taxes of 0.005% are due over the full amount of gains.

For day trade operations, the income tax reaches 20% of profits, and the withholding tax other 1%.

All costs and fees paid for investing can be deduced from the income tax amount, including those from BMF&Bovespa. In case of losses, a compensation can be applied in any gains in the subsequential months, as long as the operations are similar.

The payment of taxes is the responsibility of the investor himself, except when the tax is direct at source and must be calculated and paid monthly on the last business day of the month subsequent to the determination. The calculation is performed over the term of the contract and not monthly.


5. Example

1. Arábica Coffee Futures

Let’s suppose a coffee producer has a plantation that produces about 5,000 sacks. He expects coffee prices to drop in the next few months, and wants to make sure he can get a minimum price for their output. So he decides on selling coffee futures, but not for 100% of his output, only for 3,000 sacks. If he does, he can make profits from falling prices.

As the standard contract comprise 100 sacks, the producer is selling 30 contracts, as follows:

Number of contracts = 3,000 sacks (tonnage to be hedged) / 100 (contract size) = 30 contracts

Consider the following figures:

Output in sacks 3.000
Contract size 100
Price per sack US$ 68,00
Contracts sold 30

As days go by, then we have (daily settlements):

Date Daily updates Daily settlements
D+0 US$ 68,00 0,00
D+1 US$ 67,00 3.000,00
D+2 US$ 65,50 4.500,00
D+3 US$ 65,75 -750,00
D+4 US$ 65,80 -150,00
D+5 US$ 64,50 3.900,00
D+60 (Maturity) US$ 64,10 1.200,00
Total 11.700,00

D+0: in the first day, 30 contracts are sold for US$ 68.00 per sack.

D+1: Coffee prices dropped to US$ 67.00.  Thus, the daily change is found from the difference between the current and the previous quotations (US$ 67.00 – US$ 68.00) times the number and size of contracts (30 * 100 = 3,000.00). So, as prices fell down and the producer is actually ‘sold’ in futures, we shall have a positive adjustment of US$ 3,000.00.

D+2: another positive review of US$ 4,500.00. (US$ 65.50 – US$ 67.00) * (30 * 100) = US$ 4,500.00.

D+3: prices soar, so we have a negative adjustment. (US$ 65.75 – US$ 65.50) * (30 * 100) = – US$ 750.00.

D+4: another negative review from hiking prices. (US$ 65.80 – US$ 65.75) * (30 * 100) = US $ 150.00.

D+5: prices fell again, and we have a new positive review. (US$ 64.50 – US$ 65.80) * (30 * 100) = US$ 3,900.00.

And so on until the expiring date. It is there that we know if the producer of Arabica Coffee will make a profit or loss on the transaction Arabica Coffee Futures. If at maturity the price of Arabica coffee close the US $ 64.10, the result is the following:

1. Output is sold for spot prices, or 3,000 sacks for US$ 64.10 each, making revenues of US$ 192,300.00 (3,000 * US$ 64.10).

2. Profits of US$ 11,700.00 from coffee futures after all daily updates accounted (sum of all positives and negatives daily settlements).

3. Total income reached US$ 204,000.00, summing revenues and profits from futures (US$ 192,300.00 + US$ 11,700.00). It worked as the producer had sold sacks for US$ 68.00 each, rather than for spot prices of US$ 64.10.

4. To find the operation’s gains in BRL, you need to apply the daily PTAX rate. If PTAX is equal to 2.39, the income reaches BRL487,560.00.

2. Mini Arabic Coffee Futures

The owner of a food company needs to buy 6 tonnes of coffee for the next 3 months. He needs to make sure a minimum price for the coffee, to optimize his results. He considers the current price very good for the purchase. In order to hedge against price floats on coffee, he decides on buying 1000 sacks of coffee on futures. As the mini contract is equal to 10 sacks each, he needs to buy 100 contracts, as follows:

Number of contracts = 1,000 sacks (volume to be hedged) / 10 (contract size) = 100 contracts

Consider the following figures:

Output in sacks 1.000
Contract size 10
Price per sack US$ 47,00
Contracts sold 30

As days go by, then we have (daily settlements):

Date Daily updates Daily Settlements
D+0 USD 47,00 0,00
D+1 USD 46,65 -350,00
D+2 USD 46,90 250,00
D+3 USD 47,40 500,00
D+4 USD 47,93 530,00
D+5 USD 48,88 950,00
D+60 (Maturity) USD 48,55 330,00
Total 2.210,00

D+0: in the first day, 100 contracts are purchased for US$ 47.00 per sack.

D+1: Prices drop to US$ 46.65.  Thus, the daily change is found from the difference between the current and the previous quotations (US$ 46.65 – US$ 47.00) times the number and size of contracts (10 * 100 = 1,000.00). As prices fell and the investor is long on futures, then we have a negative adjustment for his protfolio of US$ 350.00.

D+2: a positive adjustment of US$ 250.00. (US$ 46.90 – US$ 46.65) * (10 * 100) = US$ 250.00.

D+3: prices up and the position once more is positively adjusted. (US$ 47.40 – US$ 46.90) * (10 * 100) = US$ 500.00.

D+4: another hike and the position is up. (US$ 47.93 – US$ 47.40) * (10 * 100) = US$ 530.00.

D+5: prices keep increasing as well as the position. (US$ 48.88 – US$ 47.93) * (10 * 100) = US$ 950.00.

And so on until the maturity date. It is there that we know if the operation had a profit or loss. If at maturity the price of Arabica coffee close the US $ 48.55, the result is the following:

1. Sacks of coffee are purchased at spot prices, or 1,000 for US$ 48.55 each, leading to total expenses of US$ 48,550.00 (1.000 * US$ 48.55).

2. Profits of US$ 1,550.00 from futures after all daily updates accounted (sum of all positives and negatives daily settlements).

3. Total expenses reached US$ 47,000.00, which represents the total gross expenses minus profits from investing in futures (US$ 48,550.00 – US$ 1,550.00). It works as he was paid only US$ 47.00 per sack, rather than current spot prices of US$ 48.55.

4. To find the operation’s gains in BRL, you need to apply the daily PTAX rate, If PTAX equals to 2.1521, profits reach BRL3,335.76 (US$ 1,550.00 * 2.1521). Total expenses reached R$ 101,148.70 (US$ 47,000.00 * 2.1521).

*Taxes and transaction costs have been disconsidered.


6. Advantages

  • The top advantage for Arabic Coffe futures is the possibility of hedging and protecting companies against price changes, which gives producers and food companies more safety to planning and reinforcing their cash flow.
  • Speculation is a strong possibility and can produce considerable profits, with a relatively small investment. If investors think the price will fall, he may sell futures contracts Arabica Coffee, without investing money (only the initial margin) with your profit or loss on a daily basis in everyday settings as price variation of sacks.

7. Disadvantages

  • Daily settlements;
  • Guaranty margin;
  • Income taxes;
  • Expiry dates, so you cannot undefinedly carry up positions, needing to postpone to a new expiry date if necessary;
  • High risk as variable income investment.

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