1. What is it?
It’s possible to trade with ethanol futures at BM&F. The contract’s object is the hydrated ethanol used as fuel, according to specs from Agência Nacional de Petróleo -ANP (National Petroleum Agency), the local regulator.
Trading unit is the cubic meter. Each cubic meter contains 1,000 liters, with prices in BRL per cubic meter. The minimal lot (1 contract) corresponds to 30 m³, or 30,000 liters of hydrated ethanol. 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 ethanol delivered must meet BM&F requirements and its volume has a tolerance of 3% per contract.
Deliver the physical commodity can bring transportation expenses, distribution, storage, maintenance, cleaning, etc. If the investor does not want to receive physical merchandise, have their positions financially settled on maturity (most cases).
Ethanol’s future market has been created to offering cane producers, companies and economic sectors some protection against changes on ethanol prices. Cane producers, for instance, must hedge their businesses against prices drops on ethanol, to assure minimum revenues from their activities. Ethanol mills are constantly afraid of hikes on alcohol prices, as that make cane prices to soar. Likewise, several sectors like transports and logistics fear any ethanol pricing increase, as it directly affects their costs and forecasts.
Thus, trading with ethanol futures may allow producers to assure a fair pricing for their crop, covering plantation, harvest and other costs and making the activity profitable. On the other corner, cane and ethanol buyers can find better offers and opportunities.
Ethanol pricing floats according to the physical market development, as well as future prices. 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.
Ethanol trading terminology can be found from using the following factors:
1. Ethanol trading code is “ETH”.
2. The letter corresponds to the expiry month, as follows:
3. Expiry year.
Example: for trading with an Ethanol future expiring by July 2014, we use the following code:
ETH N 14
Ethanol futures are traded with the following specs:
|Trading unit||30 cubic meters, equal to 30,000 liters|
|Quotation||BRL per cubic meter|
|Minimal Quotation Change||R$ 0,50 per cubic meter|
|Maximum Quotation Change||6% over the previous day closing price|
|Standard Lot||1 Contract|
|Position Limits||800 contracts or 25% of the opened position for a same expiry date|
|Trading Timetable||9am – 3pm (Regular Trading) / 4h05pm – 6pm (After Market)|
|Last trading day||Last work day of the expiry month|
|Guaranty Margin||6.31% of traded amount (updated daily from stock exchange’s)|
It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of ETH futures. The settlement of day trades is performed automatically on the first business day following the date of closing of the business.
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 ETH 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.
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 ETH contracts, the guaranty margin is aproximately 6.31% of the total invested amount.
Costs from trading ETH 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 ETH futures contracts, the fees are charged according to the following table:
|Number of contracts||Value per contract|
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 ETH contract it
reaches BRL3.12 per contract.
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 ethanol futures, fees reach 0.0277% 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 ETH futures are estimated as follows:
|Number of contracts||Value per contract|
Expiration dates for ETH futures can be set up for any month in the year. The expiration date as well as the last trading session happen by the last work day of the expiry month.
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, in the same number of contracts at liquidation value. 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 bought in Ethanol futures contracts, just only sell these contracts. If sold, just buy, always in the same amount.
3. Profitability and risks
Both risks and profits from investing in ethanol are related to the price changes for the alcohol in spot and future markets. Price changes can happen due to a number of factors, mostly related to demand and supply fundamentals. If an investor buys a contract and prices drop, he loses money. If he sells contracts while prices are increasing he is also making losses.
Ethanol futures are widely used as a hedge instrument, for protecting producers and consumers against price changes and adverse conditions.
Taxes over ethanol 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.
Let’s take a sugar cane producer as example, whose output reaches 600 m³. This producers is afraid that prices drop, which could affect his profit margins and revenues. In order to hedge his businesses against any drop on alcohol prices, he decides to sell ethanol futures. Thus, he can earn from falling prices.
As each contract comprises 30m³ (or 30,000 liters), he sells 20 contracts, as follows:
Number of contracts = 600m³ (output) / 30 (contract size) = 20 contracts
Consider the following figures:
|Contract size (m³)||30|
|Price per m³||R$ 390,00|
As days go by we have the following results (daily settlements):
|Data||Daily updates||Daily settlement|
|D+60 (Maturity)||R$ 396,40||-1.788,00|
D+0: in the first day, 20 contracts are sold for R$ 390.00 per m³.
D+1: prices drop, being traded at R$ 387.58. Thus, the daily change is found from the difference between the current and the previous quotations (R$ 387.58 – R$ 390.00) times the number and size of contracts (20 * 30 = 600). As prices dropped we have a positive adjustment of R$ 1,452.00.
D+2: a negative adjustment of R$ 492.00. (R$ 388.40 – R$ 387.58) * (20 * 30) = – R$ 492.00.
D+3: prices hike and a new negative correction takes place. (R$ 391.12 – R$ 388.40) * (20 * 30) = – R$ 1,632.00.
D+4: another hike and prices are again adjusted down. (R$ 391.50 – R$ 391.12) * (20 * 30) = R$ -228.00.
D+5: yet another increase and negative adjustment. (R$ 393.42 – R$ 391.50) * (20 * 30) = R$ -1,152.00.
And so on until the expiring date. It is there that we know if the producer of sugar cane will make a profit or loss on the transaction Ethanol future. If prices then reach R$ 396.40, results will be the following:
1. Ethanol is sold at spot prices for R$ 396.40, making revenues of R$ 237,840.00 (600 m³ * R$ 396.40).
2. Losses of R$ 3,840.00 from the futures operation after all daily updates accounted (sum of all positives and negatives daily settlements).
3. Producer’s total income reached R$ 234.000,00, as he actually had losses on futures (R$ 237,840.00 – R$ 3,840.00). It worked like he had sold the output for R$ 390.10 per m³ rather than spot prices of R$ 396.40.
*Taxes and transaction costs have been disconsidered.
- The main advantage of ethanol futures is the possibility of hedging positions against market moves, providing more flexibility to sugar cane producers, processores, mills and users in general to better plan your cash flow.
- Speculating is possible on ethanol markets. If an investor has a hunch that prices are going down, he can sell ethanol futures with no initial cash needs, making profits or losses in a daily basis, according to the changes in the price of a m³.
- Daily settlements;
- Guaranty margin;
- Income taxes;
- Expiry dates, so you cannot undefinedly carry up positions, needing to postpone to a new maturity date if necessary;
- High risk as variable income investment.