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Cocoa Futures and Options Education
Cocoa futures and options trading quick facts:
The History of Cocoa and Cocoa Futures
Trading
Cocoa was originally combined with spices and served as a
luxury drink in the Aztec empire. The Aztec Emperor,
Montezuma, shared the cocoa and spice beverage with the
explorer and later conqueror of the Aztecs, Hernando Cortez.
The cocoa was brought back to Spain in the 16th
century by Cortez and his Conquistadores. For nearly a
century, chocolate (usually made from cocoa, sugar, cinnamon
and vanilla) became an exclusive drink of the Spanish Royal
Court, until it gradually achieved a wider popularity in
cocoa houses of major European cities when it became less
expensive.
In 1828 cocoa began the great
transformation from a beverage to a solid form. The
discovery was made that a liquid cocoa butter (called
liquor) could be pressed out of ground cocoa beans and then
used as a base to make chocolate candy. Swiss candy maker
Daniel Peter's invention of milk chocolate 40 years later
further increased the attraction for chocolate and the
demand for cocoa beans.
In
1925 the world's first cocoa bean future was started at the
New York Cocoa Exchange. In 1986 the first cocoa options
began trading. Cocoa future
trading is now a very active
future trading contract. Cocoa options on the
cocoa futures
contracts have enjoyed much higher volume and consequently
much greater liquidity recently.
During the September 11 terrorist attacks
the Coffee, Sugar and Cocoa Exchange (CSCE) was destroyed
but within days the cocoa futures and cocoa options markets
were once again trading. This is a testament to the strength
and viability of the soft futures markets. The CSCE has
since merged to become part of the New York Board of Trade
(NYBOT) who merged with The Intercontinental Exchange (ICE).
The ICE is still located in New York.
Cocoa Economics
Cocoa Supply
The cocoa trade is strictly a tropical
plant, thriving only in hot, rainy climates with cultivation
generally confined to areas not more than 20 degrees north
or south of the equator. The tree takes four or five years
after planting to yield cocoa beans and from eight to ten
years to achieve maximum production. When ripe, these pods
are cut down and opened, and the beans are removed,
fermented and then they are dried.
The cocoa butter extracted from the bean
is used in a number of products, ranging from cosmetic to
pharmaceuticals, but its main use is in the manufacture of
chocolate candy.
Currently, the Ivory Coast and Ghana are
the world's leading cocoa producing nations. Recent
estimates are 50% of the world's cocoa originates there.
Conflict and government turmoil in the Ivory Coast region
has hindered cocoa production and added considerable
volatility to the cocoa futures markets over recent years.
Indonesia ranks next among major world producers, followed
by Brazil, Nigeria and Malaysia.
Cocoa Demand
Recently, the leading cocoa bean
importing nations are the Netherlands, United States and
Germany. These countries accounted for about 54% of world
imports in the past. The U.S. is the leading importer of
cocoa products such as cocoa butter, liquor, and powder -
accounting for 12% of world imports in recent years.
The Role of the Exchange
and Cocoa Futures
The
(NYBOT) recently merged with the (ICE) and is the world's
premier forum for cocoa futures and options trading.
Cocoa future trading
and cocoa option trading has gained
much popularity in recent years and liquidity has increased
accordingly.
Trading Cocoa Futures
A cocoa futures contract is a
standardized, binding agreement to make or take delivery of
a specified quantity and grade of a commodity at an
established point in the future and at an agreed upon price.
A contract buyer is obligated to take delivery of cocoa
according to contract terms at a specified date, while
sellers are obligated to make delivery. Buyers are
considered to be "long" and sellers "short" the futures
contract. "Standardized" means the terms, size and duration
of the contract are predetermined and meet certain criteria.
The only negotiable variable is the contract price.
Margin
Toward ensuring contract performance, the
Exchange requires that market participants make original and
variation margin payments. Original margins are "good faith
deposits" established to ensure market participants will
meet their contractual financial obligations.
Leverage
A major attraction of cocoa futures
trading for investors is leverage. Since futures
transactions do not require full advance payment for the
commodity (just the margin), the buyer of a futures contract
which increases in value (or the seller of a futures
contract which decreases in value) can realize a profit
which can be substantial in relation to the commitment of
capital. Assume that an investor can purchase cocoa futures
contracts (each representing 10 metric tons of cocoa) with a
$1,100 margin deposit. If the investor bought one contract
at $1,250/metric ton (12,500 worth of cocoa) and sold the
contract when cocoa reached $1,410/metric ton, he would
realize a profit of $1,600 ($160 x 10 metric tons = $1,600)
- a 145% return on the initial margin deposit, which is
returned when the position is liquidated.
That's leverage, and it can be a powerful
investment tool. Of course, leverage works both ways. If
cocoa futures prices were to move opposite from the
anticipated direction, an investor could lose the entire
margin deposit and more. Futures trading is very risky.
Trading Cocoa Future
Options
In 1986, cocoa futures options began
trading. 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
alike are increasingly realizing their vast potential. As a
result, cocoa options volume has grown considerably.
Buyers
Cocoa options buyers obtain the right,
but not the obligation, to enter the underlying cocoa
futures market at a predetermined price within a specific
period of time. A "call" option confers the right to buy (go
long) futures, while a "put" option confers the right to
sell (go short) futures. The predetermined price is known as
the "strike" or "exercise" price, and the last day when an
option may be exercised is the "expiration date". Buyers pay
sellers a premium for their option rights.
Because an option holder is under no
obligation to enter the cocoa futures market, losses are
strictly limited to the purchase value: there are no margin
calls. If the underlying cocoa futures market moves against
an option position, the holder can simply let the option
expire worthless. On the opposite side, potential gains are
unlimited, net of the premium cost. That feature allows
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 futures hedge, where gains in
the cash market are offset by futures market losses.
Cocoa option holders can exit their
position in one of three ways: exercising the option and
entering the cocoa futures market, selling the option back
in the market, or letting 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 cocoa
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 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 futures market at any time upon exercise, they are
required to maintain a margin account similar to that of for
futures. 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 futures contracts. The
Exchange generally lists seven strike prices for each option
month: one at or near the futures price, three above and
three below. As 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 cocoa option strike price and the
current cocoa 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 prices for
calls, above for puts). An option not profitable to exercise
is "out-of-the-money" (strikes above futures prices for
calls, below for puts). "At-the-money" options have strike
prices at or very near futures prices. In general, an
option's premium is at least equal to its 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 option's 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 cocoa futures market. Because high levels
of volatility increase the probability that 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 Month
Cocoa options are traded on futures
contracts having March, May, July, September and December
delivery periods. The option month refers to the futures
contract delivery month rather than the month in which the
cocoa option actually expires.
In general, the last trading day for
cocoa options is the first Friday of the month proceeding
the cocoa futures contract delivery month.
Contract Specifications for Cocoa Future
contracts
Trading Unit
10 metric tons (22,046 pounds)
Trading
Hours
8:00 a.m. - 11:50 a.m. closing period
commences at 11:45 am (NY time) (Verify with exchange)
Price
Quotation
Dollars per metric ton
Delivery
Months
March, May, July, September, December
Ticker
Symbol
CC
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