Buying Coffee Put Options to Profit from a Fall in Coffee Prices

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How to trade coffee

If you’re looking to trade coffee, it’s important to understand the intricate, multi-billion-dollar economy it has created over the years. Here, we’re going to discuss coffee trading and give you more insight into the industry.

Coffee trading basics

Coffee is one of the most highly-traded commodities in the world – the market is worth more than $100 billion annually. 1 Here are few useful things to know before you start trading coffee.

Where is coffee grown?

Coffee is grown in more than 50 countries, all with tropical and sub-tropical climates, across what is known as ‘the coffee belt’. The top producers of coffee are Brazil, Vietnam and Colombia. 2

Rank Top producers Coffee production (in metric tonnes)
1 Brazil 2.6 million
2 Vietnam 1.7 million
3 Colombia 0.81 million

Depending on the variety of coffee, it can be grown in higher and lower altitudes. Higher altitude crops are grown closer to the equator, in countries such as Ethiopia and Colombia. While lower altitude crops are grown in areas with specific dry and rainy seasons, such as Mexico and Brazil.

What are the different coffee varieties?

There are two different coffee varieties – Arabica and Robusta. Arabica is considered the premium, more flavourful bean, so it attracts a higher market price. Robusta has a bitter flavour and contains more caffeine. Trend followers like to trade Arabica as it has more stable pricing, while traders who prefer to trade volatility lean towards Robusta.

What moves the price of coffee?

The price of coffee is moved by factors that relate to supply and demand. The factors that impact coffee prices include:

  1. The climate: c offee crops are very sensitive to changing weather conditions. If the weather is not conducive to healthy crops – especially if it becomes very cold – coffee supply decreases, and prices will likely rise
  2. Distribution costs: transporting coffee requires fuel, which means that the price of oil directly affects coffee prices. The more expensive it is to distribute, the more expensive coffee will become
  3. Geopolitics: a shaky political landscape in a coffee-producing country can disrupt supply chains and cause market volatility. This could again lead to higher coffee prices across the globe
  4. Global health issues: the ongoing debate surrounding the effects of coffee on health has an impact on its consumption, which in turn leads to heightened or lessened demand
  5. Strength of US dollar: as coffee is priced in dollars, any ups and downs in the strength of USD will impact the price of coffee. Additionally, if you’re planning on trading shares of coffee-producing companies, it’s important to learn about the factors that affect share prices

Essentially, if more people want to buy coffee than sell it, the price will rise because it is more sought-after (the ‘demand’ outstrips the ‘supply’). On the other hand, if supply is greater than demand, the price will fall. Coffee prices are notoriously volatile, because any type of interference with production or distribution can have knock-on effects.

Four steps to start trading coffee

Choose a coffee asset to trade

When you trade coffee, it is likely that you will be trading coffee futures. These are contracts in which you agree to exchange a set amount of the underlying commodity at a set price on a set date. These contracts are traded on futures exchanges – it’s important to use the right exchange for the coffee benchmark you’d like to trade.

However, there are some other ways that you can gain exposure to the coffee market. Your choice will depend on whether you want to own the physical assets or not.

For example, you could decide to trade or invest in the shares of coffee-producing companies, such as Kraft or through known retailers such as Starbucks as the shares of these companies are heavily influenced by the price of the commodity but can offer good value compared to trading coffee itself.

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Alternatively, you could use coffee exchange traded funds (ETFs), which can be used to trade coffee benchmarks, or track a basket of coffee stocks.

Decide how you want to trade

There are a range of different financial instruments you could use to trade coffee, including futures and CFDs.

Futures are the most popular way of trading coffee, offering high liquidity and volatility. However, futures contracts do have an expectation that the physical commodity will be delivered, unless the contract is rolled over, which can be a problem for some traders.

With CFD trading, you can deal on changing prices of coffee futures and options, without buying or selling the contract. CFD trading uses leverage, which means you only have to put up a small margin to gain exposure to the full value of the trade. This can magnify your potential profit – but also your potential loss. And, as you won’t ever take ownership of the underlying asset, you can go long or short – which means you can speculate on rising as well as falling coffee prices.

Alternatively, you could choose to invest in the shares of coffee companies or ETFs.

Create your risk management strategy

Once you’ve familiarised yourself with the different ways to trade coffee, you can choose which method best suits your trading strategy and risk appetite.

All trading involves risk, especially if you’re trading using leverage, which is why you need a strategy to manage your risk and protect against unnecessary losses. You can minimise your risk by attaching stops and limits to your positions. Stops will close your trade at a certain point if the market moves against you, while limits allow you to set a level to close your position and realise your profits.

Open and monitor your first trade

Once you’ve completed these steps, it’s time to enter the market. When you trade coffee with CFDs, you can speculate on both rising and falling markets. If you think the price will rise, you would open a position to ‘buy’ coffee, and if you think the price will decline, you open a position to ‘sell’. Your trading decision should be based on your analysis of the market and your trading strategy.

After you have opened your position – attaching the appropriate stops and limits – it is important to monitor your position’s progress and to keep up to date with anything that could impact the price of coffee.

Coffee trading strategies

Coffee trading strategies will depend on your personal preferences and knowledge of technical indicators. Broadly speaking, your trading strategy could take advantage of trending markets, consolidating markets or volatility.

If a coffee market is reaching higher highs and higher lows, or lower highs and lower lows, it means that the market is trending. Traders seeking to match their strategy to a trending coffee market will often use indicators such as moving averages and the MACD to identify buy and sell signals.

Trading consolidating markets

Consolidating markets are markets that remain within support and resistance levels. Traders will use historical levels of support and resistance to identify points of entry and exit within the price range. This coffee trading strategy would involve buying coffee at a known support level and selling when it reaches a point of resistance, taking advantage of shorter-term market movements.

Trading volatility

The coffee market is notoriously volatile due to its complexity and the wide range of factors that affect the price of coffee, such as unpredictable weather patterns.

Trading coffee market volatility can be challenging, but there are technical indicators that can help you. For example, when coffee price action tightens, the Bollinger Band indicator would contract to highlight a fall in market volatility. However, this could also be a pending sign of a sharp rise in volatility will occur. Many traders wait for a sharp breakout of the Bollinger Band, which demonstrates a strong directional move.

Coffee trading hours

Coffee type and location Trading hours*
Arabica ( New York) 04:15:05 – 13:30:30 (New York time)
Robusta ( New York) 04:00:05 – 12:30:00 (New York time)
Arabica ( London) 09:15:05 – 18:30:30 (UK time)
Robusta ( London) 09:00:05 – 17:30:00 (UK time)
Arabica ( Singapore) 17:15:05 – 02:30:30 (Singapore time)
Robusta ( Singapore) 17:00:05 – 01:30:00 (Singapore time)

*Hours are set by ICE and may vary. Hours will shift between March and November as the UK and US change to and from daylight savings on different days, while Singapore remains on Singapore Standard Time (UTC+8) all year round.

The Cost of a Cup of Coffee: Where Does the Money go?

Over the past few years, the specialty coffee industry has experienced a fluctuating market with coffee prices trading slightly higher than traditionally expected. A shift in the price of coffee also affects the price of the finished cup, which has led even major cafe chains to increase their menu pricing. For consumers, the increase can be a bit confusing—a cursory look at the futures market shows coffee trading around $1.75 per pound, but when a consumer purchases a pound of coffee from their favorite roaster, they are paying $9-$12 per pound. So where is all the money going?

According to Ric Rhinehart, Executive Director of the Specialty Coffee Association of America, it turns out the money being made is not in the price difference between a pound of green coffee and a pound of roasted coffee. Instead, there are a lot of smaller moving pieces that make up the overall cost in a cup of coffee.

The calculation for any cup of coffee starts at the farm gate. Typical expenses at origin include labor, fertilizer, inspections, certifications (Organic, Rainforest Alliance, Fair Trade), transportation, and membership fees (if the producer is part of a cooperative). While the costs incurred by farmers are relatively easy to identify, they can vary dramatically based on the size and location of the farm and type of coffee the farmer is producing. This makes it challenging to calculate how much it actually costs to produce an average pound of green coffee at origin.

Once the coffee has been harvested, processed, put under contract by exporters, and transferred to importers, it moves on to the roaster. Roasters take on the actual cost of coffee: the agreed-upon purchase price per pound negotiated with the contract holder, as well as any add-ons, like import/export fees and transportation. During the actual roasting process, coffee has about 18 percent loss or shrinkage, so that pound of green coffee ends up as .82 lbs of roasted coffee. What does that mean as far as cost? Let’s say a roaster buys coffee for $2.25 per pound. After the 18 percent shrinkage during the roast, the adjusted price of that same pound of coffee is $2.75. General operating expenses like labor, overhead, and packaging bring the final cost of a pound of coffee to around $6.50. The roaster needs to make a profit on that pound of coffee when it is sold to a cafe, so the final price would be in the neighborhood of $7.50 per pound.

Cafes are the final stop on the cost-analysis chain. According to Rhinehart, “One thing that every farmer everywhere knows is a cafe typically sells coffee for $3.50 a cup, and you get about 50 cups to a pound of coffee. So theoretically, there should be $175 in a pound of coffee. They know they are only getting $2.25 per pound.” If we take a closer look, however, the actual yield on the pound of roasted coffee is not 50 cups. Cafes that follow the SCAA Golden Cup brewing standards use 3.75-4oz of coffee to brew a 64oz pot of coffee. Consumers purchasing brewed coffee in a cafe setting are typically ordering 16oz drinks. This means there are about 15-17 cups of coffee per pound once it has been brewed. If the retailer sells the 16oz brewed coffee for $1.95, the gross sales generated on a pound of coffee is around thirty dollars. While it would still appear that the cafe is making well over twenty dollars in profit, there are fixed costs. Rent, labor, utilities and other general overhead must be covered before an actual profit is realized.

Now that we have a better idea of where the money is going to produce a cup of coffee, we also need to address what’s lacking in this system. The current mechanism used to determine pricing for specialty coffee is inadequate and does little to empower farmers. It does not allow farmers to price coffees based on their value instead of the price determined by the futures market. As Rhinehart notes, “The coffee market looks at coffee with a small c.” In other words, “all coffee is coffee” and the only person in this process that is truly subjected to the whims of the market is the farmer. If a roaster suddenly increases their price on wholesale coffee, the retailer has the option to raise menu prices. If a roaster is told by their importer to expect a cost increase, the roaster has the option to raise prices for their wholesale customers. If the cost of production suddenly goes up for a coffee farmer, they have few to no options, because the selling price for coffee is determined by an average market price.

The other piece of the conversation that’s missing is that roasters are not buying “coffee with a small ‘c’,” and specialty consumers are not drinking it that way. The kinds of coffee used in the specialty category drinks represents 30 percent or less of the coffee in the world. While most of these coffees are reasonably priced, top-quality coffees are becoming increasingly scarce and expensive. The good news is that at least roasters, retailers, and consumers are in agreement that not all coffee is coffee.

Calculating the true cost of a cup of coffee involves navigating a complex system where small profits are carved away at each transaction point. Unfortunately, average consumers don’t understand the whole value chain. Roasters and retailers are working to raise awareness though participating in programs like Fair Trade and direct trade, so when a consumer purchases their cup of coffee it reflects a fairly compensated and empowered producer.

Maria Hill is a freelance writer, blogger and founder of the social media management company Say Hey Girl. She has been involved in the coffee community in a variety of roles: SCAA staff member, event manager and coordinator, and volunteer. Maria resides in Sacramento where she can often be found enjoying her favorite snack: a warm glazed doughnut and any coffee from Ethiopia.

Why is buying a stock and buying a put option the same as buying a call option?

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I will try to answer your question without getting into the technical aspects.

You own a stock. You benefit from it if the price rises after you buy, you sell it at a higher price and book profit. But the markets do not work according to your wishes, and there is every chance that the stock price drops and you are making a loss. How do you avoid this?

Enter Put option.

A put option gives you a right, but not the obligation, to sell the stock at a particular price. So If you have bought the stock for $50 and you want to avoid making a loss, you buy a Put with a strike price of $50, which .

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