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Sugar Futures and Options Education
Sugar futures and options quick facts:
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.
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.
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.
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.
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